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What Are Stock Index Futures?

Sebencapital

Published
28/12/23
What Are Stock Index Futures?

DEFINITION:

Stock index futures are contracts allowing you to buy or sell a stock index on a future date at a set price.

Key Takeaways

  • Stock index futures are agreements to buy or sell contracts on a future date at an agreed-upon price.
  • Stock index futures let investors make guesses about future prices, but they can be risky if prices change too fast.
  • Stock index futures let you trade all the stocks in an index at a cheaper price.
  • Stock index futures are offered for big U.S. indexes, certain international ones, and indexes focused on specific industries.

Definition and Examples of Stock Index Futures

Stock index futures are deals where investors guess how much a stock index's price will change by settlement day, which is the day agreed upon in the contract.

  • Alternate name: Equity index futures

Let's say Joe sold a contract to Ann for Micro E-mini S&P 500 Futures (MES) worth ₹5 for each point the index changes. On the day they made the contract, the S&P 500 index was at 4,100. When the contract ended, the index was at 4,101. Even if the index moved a lot during that time, since it went up by one point on the end date, Ann owes Joe ₹5.

How Stock Index Futures Work

Stock index futures are a type of derivative, meaning real stocks aren't exchanged. Instead, the buyer and seller make a contract with terms that are unique to it. Usually, stocks are bought in lots, which can be expensive, but these contracts don't involve buying lots of stocks.

Note

Index futures are traded on the Chicago Mercantile Exchange Globex and can be accessed through your broker if they provide index futures trading.

Instead of buying the actual stocks, each investor gives a margin to a broker. This margin is the amount needed to keep the futures contracts. When they start the contract, both sides agree to pay the difference in the index's movement from the contract day to the settlement date.

Index futures linked to the S&P 500, Nasdaq 100, Russell 2000, and Dow Jones Industrial Average are available in the U.S. Here are the specifications for each contract in the table below.

 INDEXTICKERE-MINI CONTRACT SIZE MICRO E-MINI CONTRACT SIZE 
NASDAQ 100MNQ₹20 x Nasdaq 100₹2 x Nasdaq 100
S&P 500MES₹50 x S&P 500₹5 x S&P 500
RUSSELL 2000 M2K  ₹50 x Russell 2000₹5 x Russell 2000 
DOW JONESMYM₹5 x Dow Jones₹.50 x Dow Jones

The Chicago Mercantile Exchange Group offers global index futures and also futures for particular industries like utilities, healthcare, and communication services.

What It Means for Individual Investors

You can bet on stocks going up (long positions) or down (short positions) for many stocks at a lower cost than buying each stock separately, and it takes less time. With index futures, you can control more money with less capital, making your trades more efficient by using less money.

Note

It's easy to trade a lot because the futures market is open almost all the time, nearly 24 hours a day for six days a week. Sometimes, you might end up chasing the market instead of sticking to your planned strategy.

The risks in index futures are similar to any futures trading. When contracts end, it's hard to predict which way the markets or indexes will go. Sometimes, you might not be able to end a position, and your orders might not happen if there aren't many trades happening.

Pros and Cons of Stock Index Futures

  • Speculation opportunities: You can guess future stock prices and get more power. You can trade securities all the time in well-regulated markets and don't need to own the stocks in the index that the futures contract involves.
  • Trading costs: When you buy stock index futures contracts, you pay much less than the listed price for the stocks in the index tracked by the futures contract. For instance, investing ₹2,480 per share for 100 shares of a fund following the S&P 500 Index would total ₹248,000. However, buying one S&P 500 futures contract (or 100 shares of the index) costs significantly less.

Cons Explained

The disadvantages of trading in futures are all about high risk and the necessity of holding cash:

Risk of leverage: An issue with investing in index futures is the chance of high risk when you buy and sell these contracts. You might end up with a lot of debt and lose all your investment if the market moves in the wrong direction.

When trading stock index futures, it's important to remember this: you need to have cash in a margin account at a brokerage firm to trade. If your margin account runs low, your broker will ask you to add more money—this is called a "margin call." If you can't add the money, you might end up quickly borrowing a lot to fund your account, which can be risky. In the past, many traders faced big debts and even lost their belongings due to margin calls.

Are Stock Index Futures Worth It?

Trading index futures can be costly when considering fees and maintaining a margin account, which might have high requirements depending on your broker. While these futures let you trade a bunch of stocks for less money, it's important to know that there's a risk of losses.

If you're planning to invest in stock index futures, it's a good idea to talk to an investment advisor or a financial expert first. They can give you useful advice and help you make careful investment choices.

Written by Sauravsingh

Techpreneur and adept trader, Sauravsingh Tomar seamlessly blends the worlds of technology and finance. With rich experience in Forex and Stock markets, he's not only a trading maven but also a pioneer in innovative digital solutions. Beyond charts and code, Sauravsingh is a passionate mentor, guiding many towards financial and technological success. In his downtime, he's often found exploring new places or immersed in a compelling read.

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