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STOCK TRADING VS FUTURES CONTRACT TRADING

 

How do we explain the misconception of distinguishing stock market with futures contract transaction?

 

The biggest difficulty actually comes from the perception of incoordination between institutions. The incoordination between institutions also resulted in incoordination of financial sector development in Indonesia therefore each institution seems to assign different policies.

 

In the above context, we see the misconception as follows:

Bank of Indonesia controlled currency trading. Therefore, futures contract of currency and interest rate automatically considered under the jurisdiction of Bank Indonesia.

 

Bapepam manages stock trading, therefore the trading of stock index futures also considered under the same jurisdiction. Meanwhile, because futures index trading controlled by Industrial & Commerce Department, the scope misunderstood by limiting the activity only for futures contract transaction of real commodity and considered inappropriate for financial commodity.

 

The following technical analysis excerpted from July 1995 edition of Futures Magazine. It is not concerned with the aspect of policy, but only concerned with technical description that distinguish stock trading with future index one. However, the purpose of this writing is to provide some insights for all decision makers in order not to arranged financial policies solely based on “the search of power”.

 

The first difference between stock market and futures contract market is the object of formation. The stock market formed to mobilize fund in order to accumulate capital. Therefore, one of the tasks of financial market authority is to maintain transparency between market participants, for instance by reviewing registration statements and continuous disclosures.

 

Futures contract market does not have participants and registration statements. The function is to facilitate risk shifting and price discovery. Therefore, the main function of futures market authority is to maintain market integrity in the process of price discovery.

Therefore, stock market provides secondary market that function as stock trading forum. Meanwhile, futures market provides futures contract facilities that protect hedgers from price fluctuation risks.

 

Second, stock could be bought and kept for unlimited time in order to receive dividend and capital gain from price increase. Meanwhile, futures contract have due time. Therefore, it is not possible to keep for unlimited time. When the contract is due, if a contract not closed with offsetting transaction, then real delivery must be carried out in order to settle transaction. If it could not be carried out, like stock index futures trading, then settlement in due time must be arranged in a very specific and certain method.

 

Third, first time stock publication requires full payment, at least the nominal value of the stock. At secondary market transaction, unless margin trade which requires special arrangement, transaction value also require full payment from investors. In futures contract transaction, full payment only carried out when settlement reached. In early transaction, investors only require to pay good faith fund – like bond performance - which generally not exceed 10% of the contract value. The nominal is called initial margin. If price moves to opposite direction of investor prediction, he/she will be asked to add additional margin, the amount of “unrealized losses”, which is the difference between the arranged contract price and the latest one. Otherwise, if price moves to positive side, margin deposit will be return along with the profit received when the contract is closed.

 

Therefore, form speculators point of view, futures contract transaction creates financial leverage that is the opportunity to gain profit or suffer loss in considerable amount for a relatively small amount of capital. For those who succeed, futures contract transaction offers very high profit. Otherwise, for those who failed, must also be willing to accept risk of losses in considerable amount. In a more macro language, futures contract transaction marked by a relatively faster price changes compare with stock market.

 

Fourth, short selling in stock mostly banned. If allowed, it must follow very strict rules, for instance up-tick requirement, regulation about dividend received during short period and the availability of lending and borrowing market. Meanwhile, in contract futures transaction all selling positions are basically short selling.

 

Fifth, the amount of stock circulated in certain time also limited by very strict rules, whereas individual shareholders have no restriction for ownership. Futures contract transaction applied opposite rules. Open position limit for each market participant made strictly, but there is no actual limit for open position.