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 is the meaning of index futures? ›
What are Index Futures? 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.
What are the different types of futures? ›
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.
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 is the difference between ETF and index futures? ›
Futures are more cost-effective than ETFs since they have fewer transaction costs, holding costs, and margins than ETFs.
What are the most commonly traded futures? ›
Commodities attract fundamentally-oriented players including industry hedgers who use technical analysis to predict price direction. The top five futures include crude oil, corn, natural gas, soybeans, and gold.
What futures tell us? ›
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.
What are the three most important indexes? ›
In the United States, the three leading stock indexes are the Dow Jones Industrial Average, the S&P 500, and the Nasdaq Composite.
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.
Some of the types of financial futures include stock, index, currency and interest futures. There are also futures for various commodities, like agricultural products, gold, oil, cotton, oilseed, and so on.
What is the best order type for futures? ›
The fastest and easiest way to enter or exit a futures position is with a market order. A market order is executed as soon as it reaches the exchange. Buy market orders are filled and matched against the current best ask price. Sell market orders are filled and matched against the current best bid price.
Which futures are most volatile? ›
Crude oil (CL) provides decent volume, but it also requires the most margin and is the most volatile.
How do you play index futures? ›
The mechanism behind index futures involves a commitment between a buyer (holding a long position) and a seller (holding a short position). The buyer anticipates a future increase in the index's value, while the seller predicts a decline.
What do the S&P 500 futures mean? ›
S&P 500 Futures are financial futures which allow an investor to hedge with or speculate on the future value of various components of the S&P 500 Index market index. S&P 500 futures contracts were first introduced by the Chicago Mercantile Exchange in 1982.
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.
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.
