Index futures are contracts that allow a trader to purchase or sell a financial index today and have it resolved at a later date. Traders speculate on the price direction of an index, such as the S&P 500, using index futures. Index futures are also used by investors and investment managers to protect their stock investments from losses.
How do Index Futures Work?
Index futures, like all futures contracts, provide the trader or investor the power and responsibility to deliver the contract's cash value based on an underlying index at a future date. The trader is bound to provide the cash value on expiry unless the contract is unwound before expiration by an offsetting deal.
An index is a measurement of the price of a single item or a collection of assets. Index futures are derivatives, which means they are based on an underlying asset (the index). Traders utilize these products to trade a wide range of assets, including stocks, commodities, and currencies. To bet on the index's appreciation or depreciation, an investor could buy or sell index futures on the S&P 500.
How to Trade Index Futures?
In index futures investing or trading, the buyer and seller lock purchase and sell bids. Both parties agree to close their holdings lawfully at a specific price and on a specific date. Traders' buy and sell orders are placed by a futures broker on their behalf. The next step is to create a long and short position for buy and sell orders, with initial and maintenance margins.
The payment of futures contracts is entirely based on cash. On the expiration date, the seller and buyer can also pay and receive the difference in the agreed-upon contract price in cash. Simply said, a higher price results in a profit for the buyer, while a lower price results in a loss for the seller.
Types of Index Futures
Index futures are of several types, and they are mentioned below:
Nifty 50: 50 underlying securities make up the BSE's Sensitive Index or Sensex.
Nifty IT: Shares of information technology make up the underlying assets. The fortunes of these futures would depend on the performance of the overall sector.
S&P BSE Sensex: 30 underlying securities make up the BSE's Sensitive Index or Sensex.
Nifty Bank: Bank shares make up the index, so how the Nifty Bank futures would perform would depend on how well the banks are doing.
S&P BSE Bankex: The futures have banking stocks listed on the Sensex.
S&P BSE Sensex 50: This index is inclusive of 50 stocks instead of the 30 that make up the Sensex.
S&P BSE Bharat 22 Index: This index is made up of 22 central public sector enterprises.
Others: You could also trade in these futures from foreign stock exchanges.
Importance of the Index Futures
Due to a lack of cash to make large stock purchases, futures contracts are one of the most effective trading options. It's a derivative-based investment that allows traders to spend less while earning more. Furthermore, there are two methods for using equities or stock index futures:
Experienced traders can use futures contracts to bet on the future direction of an underlying asset or index. Simply put, it means that instead of buying or selling futures contracts, investors can wager on a group of assets by speculating on a bullish or bearish market. Traders must stay current with market developments in order to lock in successful positions when speculating.
Many traders utilize futures contracts to hedge against losses incurred as a result of excessive stock price swings. When stock prices fall, investors with a stock portfolio or equity index options sell futures contracts to reduce their risk of losing money. Futures contracts gain value in this case, as opposed to stock prices falling.
FAQs
Index futures are contracts to buy or sell a financial index at a set price today and are settled in the future. These contracts were initially meant only for institutional investors but have been open for decades to anyone. Portfolio managers use index futures to hedge their equity positions against a loss in stocks.
What are the pros and cons of index futures? ›
They are classified into several forms, including equity, sector, foreign, volatility (VIX), and dividend index futures, each serving a distinct investment goal. Benefits include leverage for higher returns, diversification options, and good risk management; drawbacks include high risk owing to leverage and complexity.
What are futures and its types? ›
There are different types of futures, both in the financial and commodity markets. Stock, index, currency, and interest futures are examples of financial futures. Futures are also available for agricultural products, gold, oil, cotton, oilseed, and other commodities.
What are the most common index futures? ›
E-mini S&P 500 futures (/ES) are the most actively traded U.S. equity index futures contract, with 1.81 million contracts changing hands on average each day during 2023, according to the CME Group's exchange data.
What is an example of index futures trading? ›
Index futures example
If you think that the FTSE 100 is going to increase from 7300.00 to 7905.50 in the next three months, you could decide to buy (go long) two FTSE 100 futures contracts, valued at £5 each. The total value of your position would be £73,000 (a buy price of 7300 x 2 contracts x £5).
What is futures trading in simple terms? ›
Futures are contracts to buy or sell a specific underlying asset at a future date. The underlying asset can be a commodity, a security, or other financial instrument.
Why do people trade index futures? ›
Speculating with futures
Futures can be used to speculate on the market to attempt to profit from price swings in commodities, stock indices, and financial instruments. Speculators are the primary participants in the futures market, willingly taking risks that hedgers wish to transfer.
What are the benefits of futures? ›
While futures can pose unique risks for investors, there are several benefits to futures over trading straight stocks. These advantages include greater leverage, lower trading costs, and longer trading hours.
What are the disadvantages of futures? ›
Following are the risks associated with trading futures contracts:
- Leverage. One of the chief risks associated with futures trading comes from the inherent feature of leverage. ...
- Interest Rate Risk. ...
- Liquidity Risk. ...
- Settlement and Delivery Risk. ...
- Operational Risk.
Futures look into the future to "lock in" a future price or try to predict where something will be in the future; hence the name. Since there are futures on the indexes (S&P 500, Dow 30, NASDAQ 100, Russell 2000) that trade virtually 24 hours a day, we can watch the index futures to get a feel for market direction.
Financial Futures: Contracts that trade in the future value of a security or index. For example, there are futures for the S&P 500 and Nasdaq indexes. There are also futures for debt products, such as U.S. Treasury bonds and German Bundesobligation (BOBL) bonds.5.
How to trade futures for beginners? ›
How to trade futures
- Understand how futures trading works.
- Pick a futures market to trade.
- Create an account and log in.
- Decide whether to go long or short.
- Place your first trade.
- Set your stops and limits.
- Monitor and close your position.
An index futures contract works just like a regular futures contract. It is a legally binding agreement between a buyer and a seller that allows traders to buy or sell a contract on a financial index and settle it at a future date. An index futures contract speculates on where prices move for indexes like the S&P 500.
Which futures are best to trade? ›
What futures are most profitable? Trading in futures markets such as the Micro E-Mini Russell 2000 (M2K), Micro E-Mini S&P 500 (MES), Micro E-Mini Dow (MYM), and Micro E-Micro FX contracts can be highly profitable due to their distinct market characteristics.
How to trade in index futures? ›
How to Trade Index Futures? In index futures investing or trading, the buyer and seller lock purchase and sell bids. Both parties agree to close their holdings lawfully at a specific price and on a specific date. Traders' buy and sell orders are placed by a futures broker on their behalf.
How do you play index futures? ›
How to Trade Index Futures? In index futures investing or trading, the buyer and seller lock purchase and sell bids. Both parties agree to close their holdings lawfully at a specific price and on a specific date. Traders' buy and sell orders are placed by a futures broker on their behalf.
What is the difference between the S&P 500 futures and the index? ›
While the S&P 500 Index is based on the cash price of stocks being traded within the benchmark, the S&P 500 futures reflects expectations of the future value of the index, which makes it a leading indicator for the U.S. stock market outside normal trading hours.
What is the US dollar index futures? ›
Description. The ICE U.S. Dollar Index (USDX) futures contract is a leading benchmark for the international value of the US dollar and the world's most widely-recognized traded currency index.
