Types of Shares
Ordinary shares
Ordinary shares aka Common shares – this type of share gives shareholders voting rights and dividends when issued.
Preference shares
Preference shares provides no voting rights but when dividends are issued moneys are allocated ahead of common stock holders, sometimes even a fixed minimum.
Bearer Stock
Bearer Stock – Bearer Stock are stocks with no registered ownership information, whoever is physically bearing the stock is presumed to be the owner. (That’s why baddies always ask for bearer bonds in films.)
What are Stocks
Stocks are shares and shares are stocks. Essentially they are the same thing just know by different names. In the UK people most commonly say share and in the US they more commonly say stocks.
Derivatives
Derivatives come in two main flavours, Options and Futures, both Futures and Options rely on the underlying stock to set or derive their price.
Options
An option gives you the ability to by a stock in the future at a value set today, this value is known as the grant value. On the specified date you purchase the stock and the grant value, this is known as executing an option. The difference between the grant price and the current share value can be huge which is why in most cases people will execute an option and then sell the resulting shares in quick succession to crystallise that gain.
Options are often issued to employees of start-up companies in lieu of a higher salary and to incentivise the individual to make the company profitable.
Futures
Futures are a way that you can smooth the volatility of a particular share so protecting you from the a price crash, but you could lose out on a bigger profits, however you never own the stock and so you do not receive dividends, in fact most futures are traded in their own right on futures markets before maturity, we will explain why below
Futures are a contract which says you will buy or sell stock at a date in the future at an agreed price. If you are have a buy contract you are said to be adopting the long position or “going long” if you have a contract to sell you are said to be taking the short position or “going short”.
The ability to “go short” is what allows people to make money in a falling market. Let’s take a look at an example. First going long, In January you enter into a futures contract to purchase 1000 shares of Company X at £5.50 per share on the 1st of April at 10% of the share price, so the option cost you £550. The price now increases to £7.00 a share, you now have the option to either hang on to the future, you are betting that in the long term the price will increase more or you can sell the future now and make £150 (the sell price would be £700).
Let’s look at the short position. In January you enter a futures contract to sell 1000 shares of Company X at £5.50 a share on the 1st of April, remember in this situation you are betting the price goes down, the price goes down to £3.00 a share on the 1st of March. The trick now is to buy the contract back before you have to deliver the stock. If you buy the contract on the 1st of March, you pay £300 for a contract that is worth £550 you have just made £250, hence you have made more in a falling market than in a rising one.
You can only pull this trick because you are trading the you are not required to deliver anything until the future date specified in the contract. You have essentially sold before you have bought in doing so you have cancelled your obligation to deliver on the sell contract.
Hedging
Going short can be used to make a stack of cash when things are going wrong but it often used as a form of insurance, this is known as hedging. Everyone hedges, when you take out insurance on your house contents you are essentially hedging against the cost of replacing your house and its contents. In order to hedge with equities you would invest in two securities which have a negative correlation, one goes up as the other goes down this technique will never make money it just reduces your losses if the worst happens.