When it comes to diversifying your portfolio as an investor, you have a number of different options. You’ll frequently hear people talk about futures, stocks, and options as if they’re interchangeable, but what if we told you that trading futures actually offers a number of distinct advantages?
5 Reasons to Trade Futures
A lot of investors stay away from futures because they think they’re complicated, but this simply isn’t true. With the right amount of discipline and commitment, anyone can learn how to trade futures.
At its very core, a futures contract is nothing more than a binding agreement between a buyer and a seller to either buy or sell the asset or financial instrument involved at a predetermined price and time.
When compared to stocks and options – which are both totally different from one another – futures contracts offer a number of distinct advantages.
Let’s take a look at a few of them:
- Higher Leverage
The single biggest advantage of trading futures is the leverage that comes with it. An investor doesn’t have to put up the full amount – but usually just a small fraction of the total amount (typically 10 percent). In other words, an investor can get his hands involved in a $10,000 contract with just $1,000 of his own money. This is what makes trading futures so exciting. (Though it also goes the opposite way. You can easily get yourself in trouble if you aren’t careful.)
- Fixed Up Front Costs
For the most part, the margin requirements for a major futures commodity are pretty constant and well known. They don’t fluctuate very much – even over a number of years – which is contrary to option premiums that can vary rather significantly as the market shifts. This stability means traders know what to expect and are aware of how much is required to be put up as the initial margin.
- High Liquidity
You don’t have to worry about tying up your money long term. Futures contracts are traded in very significant volumes every day, which makes them highly liquid investments. For someone who has other holdings on the opposite end of the spectrum, this makes futures extremely attractive.
- Ease of Filing
Another tax-related benefit of trading futures is that you don’t usually have to provide a detailed list of each trade you made throughout the year – as is the case with securities traders. This saves you a ton of time and makes it a lot easier to manage things during tax season. However, you do still have to keep very detailed files and records. If you’re ever audited by the IRS, you’ll have to provide enough details to support your numbers.
- Better Tax Rate
Did you know that you can actually get a major tax break when trading futures, versus stocks and securities that command short-term capital gains rates? Tax professional Michael Atias explains how this works by using the example of a commodities futures trader who is married filing jointly.
“He makes $75,000.00 trading gold futures on the CME,” Atias says. “This activity falls under section 1256 contracts. His tax liability would be $1,103. If Joe made the same $75,000.00 in profit trading single stock futures or futures on indexes, the entire amount is short-term capital gains and taxed at his personal income tax rate. His tax liability would be $7,754.”
Give Futures a Chance
If you’ve never considered trading futures, you might want to give it some more thought. While stocks and options have their place, there are a number of distinct advantages that futures offer. You might find that they aren’t right for you, but many people discover that they’re highly beneficial. Now’s as good a time as any to find out!