Stock Futures are financial contracts where the underlying asset is an individual stock. Stock Future contract is an agreement to buy or sell a specified quantity of underlying equity share for a future date at a price agreed upon between the buyer and seller. The contracts have standardized specifications like market lot, expiry day, unit of price quotation, tick size and method of settlement.
Stock futures offer a variety of usages to the investors. Some of the key usages are mentioned below:
1. Investors can take long term view on the underlying stock using stock futures.
2. Stock futures offer high leverage. This means that one can take large position with less capital. For example, paying 20% initial margin one can take position for 100 i.e. 5 times the cash outflow.
3. Futures may look overpriced or underpriced compared to the spot and can offer opportunities to arbitrage or earn risk-less profit. Single stock futures offer arbitrage opportunity between stock futures and the underlying cash market. It also provides arbitrage opportunity between synthetic futures (created through options) and single stock futures.
4. When used efficiently, single-stock futures can be an effective risk management tool. For instance, an investor with position in cash segment can minimize either market risk or price risk of the underlying stock by taking reverse position in an appropriate futures contract.