ArchAngel, thanks for the long explanation -- very informative. but i stand behind my point: there is a fundamental difference between buying stock and buying a futures contract. after you have bought stock you actually own part of the company. after buying a futures contract you "own" nothing -- you have merely entered a contract with some anonymous seller. that's the very reason you don't have to "borrow" futs to short them. i just picked an ambiguous term ("intrinsic value") to describe the difference -- my bad. the classical explanation is that is that i'm buying the assets (book value) PLUS all expected future dividends of that company, in present value. for example, if a company has expected revenues of $1m a year and zero assets, then its market capitalisation (i hope i'm not using wrong term again!) should be around $20m, given 5% inflation. therefore, given the assets, share price, float, and inflation % you can derive the current poular expectation of company's future profits. i'm i right or i'm i right? - jaan
but i stand behind my point: there is a fundamental difference between buying stock and buying a futures contract. after you have bought stock you actually own part of the company. after buying a futures contract you "own" nothing -- you have merely entered a contract with some anonymous seller. that's the very reason you don't have to "borrow" futs to short them. Not really. I do agree that when you buy stock you own a share of the company, and the value of that share is not merely the book value of the company. That stock, however, is in itself a contract between the company and whoever entered into it at the time of the ipo. The terms of the contract (the right to transfer ownership, the right to a share of future profits, other shareholder's rights,) is what determines it's value. The fundamental difference between futures and stock is that in the case of stock the terms of the contract always involve a third party (the company,) which is not participating at the time of sale, so in essence you are simply transferring the ownership of contracts entered into by the company sometime in the past. In the case of futures, the contract is between you and the person you sell to or buy from, therefore the contract is simply created at the time of sale. No need to transfer the ownership of already existing contracts - no need to borrow in order to sell contracts you do not own. (I don't really know how certain issues are handled in the case of futures, so this might actually be somewhat more complicated. If person A sells to person B, then B sells to C, now B is flat, A and C aren't, so in a way B's ownership must have been transferred to C. What happens if C goes into bankruptcy? But this doesn't really change my main point - since all parties are participating at the time of sale contracts can be created at that time.) voodoo
jaan - A futures contract is a contract to own the underlying commodity at a specific price. So if I buy a gold contract @ $270, I'm saying that theoretically I'll take delivery of the contract's amount of physical gold for $270/oz. Whether I do is up to me - most futures contracts are eventually offset prior to expiration. So while splitting hairs you can say I'm not currently in possession of the gold by owning the contract, I am in control of the gold (conceptually the same thing). As far as buying stock meaning that you own a piece of the company - that's a nice theoretical, textbook description. But it's not true from a practical standpoint. What you normally own is a large premium over the real value of the company, mostly with the expectation that you're going to be able to sell it later to someone else who's willing to pay a higher premium than you paid (the so-called, "dumber investor" theory). Also, from a pragmatic standpoint, unless you're taking a big % interest in the company, the stock you buy is effectively worthless as an asset. You don't get dividends usually (primarily because of the tax code and also because so many stocks couldn't pay them if they wanted to). You don't have any say in the operations of the company (and management will usually use every scam there is to milk the company's profits (i.e., theoretically your profits) for themselves). And you only have an "asset" ownership to the extent there are any net assets left should the company breakup (and you take a backseat to everyone). So basically, you actually own no practical asset and are merely buying the hope that someone will eventually buy the stock for a higher price than you paid or the company will eventually be bought out for a premium. That unfortunately is the fundamental precept upon which the stock market is now based. Can't imagine what "asset" anyone thinks they're buying when they buy stock in the likes of AMZN or CMGI. If you do, I'd love to hear it because I'm at a loss to understand it.
voodoo, excellent points. i take back the ownership vs contract argument. so, to rephrase you, the fundamental difference between futures and stocks is that in case of futures each transaction (virtually) creates a new contract, whereas in case of stocks the amount of available contracts is limited at the IPO time. plus, the contract terms are also different, obviously. as voodoo explained, by buying stock in a company, you are buying an obligation by the company to - under certain contractual conditions - give you a cut of the future profits, shareholder rights, etc. an obligation definitely qualifies as an asset -- at least from financial point of view. however, i agree with you that traders rarely consider the stock as a contract with the company. instead we look at it as a piece of paper (or bits on the server) we'd be able to sell later at a higher price. from that, practical, point of view, there really is no difference between stocks and futures. - jaan
Wow, thanks for the dialogue everyone. I feel like I have just been to some kind of equities/futures class! It amazes me what one little question will bring out on this EliteTrader board!
jaan - A point of clarification - owning stock does NOT create any practical obligation on the part of the company to give you a cut of future profits, etc. It might if the tax laws were different and companies could more easily distribute part of their profits as dividends (although many large % owners of the stock might not want that and would vote to not do it). If you don't have controlling interest in the stock, you can't be sure of getting any cut of future profits. Let's face it, did anyone owning shares of Lucent get a cut of any profits? Hard to get any profits with the executives doing things like spending a billion dollars buying and refurbishing a golf course to be used as an executive haven (among many other stupid things). As I said, what's the "asset" being owned when holding AMZN shares? They're over $2 billion in debt, still can't turn a real net profit after all these years, and they've been milked by Bezos and other executives to the financial detriment of anyone who bothered to "invest" in that thing. If they liquidate, common stock owners get nothing. They have not future profits (yet or maybe ever). And they're so weighed down with debt service that even if Jeff Bezos manages to figure out how to turn a profit, the payments on the debt will eat it up for at least a decade. And on top of that, since most companies don't pay dividends, you'll never see any cut of a profit stream (assuming they ever produce one). There's perhaps a better case of "asset" ownership when it comes to certain blue chip stocks, but even then the stock price is most likely at a considerable premium to intrinsic value. As an owner of common stock, you are at the bottom of the ladder when it comes to getting your cut if the company liquidates (debt holders come first, then preferred stock owners, and finally if there's anything left by then the common stock owners - and that's after all the corporate options have been executed first to the further depletion of assets). Those buying AMZN stock are just betting that someone else will be dumb enough to buy it from them later at a higher price. Any idea that it's an "asset" is hypothetical. It's not much more than a trillion dollar game, but it's the one we're playing Re: futures vs. stock availability - futures contracts are bought and sold on either an opening or closing position basis. So if you sell to open, you're creating a new contract. A buy to open doesn't create a new contract though (it will if the counterparty is doing a sell to open though). In the case of stock, you're limited by the amount of stock that's currently issued (has nothing to do with any IPO). However, for practical purposes, you're limited to the available float (less whatever part of that may already have been borrowed by shorts).