What is the difference between trading in equity and futures?
What is equity trading?
Equity trading, also known as stock trading, involves the buying and selling of company ownership shares in the market using a registered trading account. Equities are freely traded on stock exchanges and are referred to by different names such as stocks, shares, or equity. When purchasing a stock, an investor can benefit from capital growth, which is realized by selling the stock for more than the initial purchase price, resulting in a capital gain. Additionally, shareholders may receive cash rewards, known as dividends, which are paid out of the company's profits at the end of each financial year. As owners of the company, shareholders also have voting rights. Finally, easy liquidity in equity trading allows investors to sell their stocks and receive cash at any time, with the settlement cycle currently at one day.
Trading in futures;
Futures are derivative products that derive their value from an underlying asset, meaning they do not have any value of their own. For instance, futures on Reliance Industries will be linked to the stock price of Reliance Industries and will derive their value from the same. Futures are traded in lot sizes and have an expiry day. If a trader buys a futures contract, they will only receive capital gains, as they will not receive benefits such as dividends or voting rights that are associated with equity. In equity, we can buy even one stock, but futures are traded in lot sizes. A trader can buy or sell futures and carry them over to the expiry day, but equity sell positions cannot be carried over to the next day.
When we buy equity shares, we need to pay the full amount of the total value. However, in futures, we only need to pay the margin amount, providing traders with high leverage. Every day's closing in the futures market, the market-to-market difference is calculated. If the closing price is below the buy price, the trader must pay the difference to the exchange. In contrast, equity market traders buy shares after paying the full amount, so they do not pay any market-to-market difference.
Futures contracts can only be held up to the expiry day, but there is no expiry day in equity, and one can hold them for an unlimited period.
Let's take the example of Reliance Industries to understand equity trading and futures trading. The market lot for Reliance Industries is 250 and the margin required is around Rs. 105,000.
In futures trading, if a trader buys a futures contract at a buy price of Rs. 2325, the total value of 250 shares will be Rs. 581,250. However, the trader needs to pay only the margin amount of Rs. 105,000. If the futures contract closes at Rs. 2305, the trader will have to pay Rs. 5000 (25020=5000) as market-to-market difference. Conversely, if it closes 15 points up at Rs. 2340, the trader will receive a credit of Rs. 3750 (25015=3750).
In equity trading, to buy 250 Reliance Industries shares, a trader needs to pay the full amount of Rs. 581,250. Let's assume that both the equity trader and the futures trader closed their positions after one week when the price of Reliance Industries had increased to Rs. 2400.
In the cash market, the buy rate was Rs. 2325 and the sell rate was Rs. 2400, which means the net profit was Rs. 2400-2325= 75. The total profit earned by both the equity trader and the futures trader would be Rs. 18,750 (75*250=18,750).
The return on investment from cash market trading for the investment of Rs. 581,250 would be 3.22% while the return from futures trading for the margin of Rs. 105,000 would be 17.85%