ETFs vs Futures: A Comparative Study

ETFs and futures have been two of the most traded assets worldwide since the 1990s. For instance, the S&P 500 e-mini is currently the world’s most liquid stock futures contract, according to the CME. Despite the fact that futures and ETFs are frequently contrasted, a lot of investors will tell you that trading futures is the better choice. We should first discuss what makes futures distinct from the other alternatives before discussing why they are superior.

Table of Contents:

Exploring ETFs

A “SEC-registered investment company that offers investors a way to pool their money into a fund that invests in stocks, bonds, or other assets” is what the SEC defines as an exchange-traded fund (ETF). In essence, an ETF combines the two primary components of traditional stock trading and mutual funds.

Exploring Futures

Investors have more control over their investments with futures. A futures contract is “An agreement to buy or sell a specific quantity of a commodity or financial instrument at a specified price on a particular date in the future” as defined by the CME Group.

Why Futures Trading Is a Better Option Than ETF Trading

Fees

The absence of a management fee is one of the main benefits of futures trading over ETFs. Purchasing an ETF typically entails paying a fee equal to a small percentage of your balance, typically 44%, whereas purchasing a futures contract does not require you to pay a management fee for the duration of the contract. Every ETF trade normally has a commission added on, which typically averages $15, in addition to a management fee. These costs might mount up and negatively impact your profits if you’re a part-time trader.

Availability

While certain ETFs allow trading after hours but they are not available for 24-hour trading, in contrast, futures trade nearly continuously, six days a week. Futures are still paramount when accessibility is crucial and time is money.

Liquidity

One more consideration when choosing between ETFs and futures is the liquidity of each investment. Liquidity in the context of investment and the stock market refers to an asset’s capacity to be bought and sold on the market swiftly. An asset can be bought and sold more quickly and provide its owner with instant financial benefit if it is more liquid.

The ETF market cannot support a buy-to-sell turnaround as quickly as the futures market, despite the fact that ETFs have strong liquidity. This is because ETFs lack the substance of futures contracts. Compared to an ETF, futures contracts are significantly more substantive and are all made in “far-out trade in dollar terms.” For example, having a futures contract gives you the ability to buy or sell that contract almost instantly because futures are traded so widely and in such large numbers. An ETF might not be able to support this kind of action.

Taxes

There are also significant tax advantages to trading futures contracts. An ETF will pay more taxes than a lucrative short-term futures trade, as per IRS Section 1256. A futures dividend is considered 60% long-term and 40% short-term for tax purposes, according to Investopedia. This is known as a blended tax. You pay taxes on 40% of your earnings at 35% and 60% of your gains at 15%, for an average rate of 23%. However, regular income tax rates apply to exchange-traded funds (ETFs), which can quickly pile up and reduce your gains.

Amount

Globally, futures contracts perform far better than exchange-traded funds (ETFs), in part because they cater to all sizes of traders. Treasury bonds, crude oil, and gold all trade at a dollar value that is between 20 to 600 times bigger than ETFs when comparing the average daily volume of futures and ETFs. The E-mini S&P 500 futures contract outtrades all ETFs combined by 2.56 times, according to the CME Group.

Leverage

Compared to ETFs, futures provide you more influence over a commodity like gold, corn, etc. Gaining more control over a commodity enables the creation of bigger profits. It takes a LOT of price movement, which is uncommon, to have a net gain with ETFs. With futures, you don’t need to observe as much movement to make a net gain because you can possess such a large volume of a commodity. Naturally, this also works in reverse, losing money is a bigger possibility while holding futures. Moreover, futures follow the actual product more closely than ETFs do.

For instance, the stock price of an oil business will fluctuate in response to changes in the price of oil, but the stock price is also influenced by other exogenous factors, which leads to significant variations in the way an ETF tracks the underlying stock. While futures and ETFs may not track at a 1:1 ratio, futures track quite closely, which offers greater stability.

Conclusion

It is evident from studying futures and ETFs that futures are the more desirable choice. Exchange-traded funds (ETFs) do not provide nearly as many advantages as futures, it’s as basic as that. Futures give you greater control over a commodity, attractive tax advantages, increased liquidity for instantaneous buying and selling, greater availability, and a more cost-effective choice since there are no fees. With advantages like these, it’s easy to understand why futures contracts almost triple the volume of exchange-traded funds.