What Do Index Futures Mean?

Today, people can buy or sell futures contracts based on a financial index that will settle later. These contracts are called index futures. Commodity options were first made available to institutional buyers, but now regular people can buy them. Traders use indices like the S&P 500 and the Dow Jones Industrial Average (DJIA) to guess which way prices will go. Benchmark futures are another way they protect their stock positions against losses.

How to Understand Index Futures

An index keeps track of the price of a thing or a group of things, like currencies, stocks, and commodities. A futures contract is a derivative that forces traders to buy or sell an underlying product at a specific price on a particular day. Because of this, an index future is a binding agreement that traders must buy or sell a contract based on a stock market index by a specific date and at a specific price.

Index futures, also known as stock or equity market commodity options, work the same way as any other futures contract. When buyers buy these, they agree to deliver the contract’s cash value based on an underlying index at a specific date and time for a price already agreed upon. The seller has to give the cash value when the contract expires unless the contract is unwound before it expires through an offsetting trade.

Index futures are a way for traders to protect themselves against changes in the price of an underlying stock index. On the other hand, the S&P 500 Index keeps an eye on the stock prices of 500 of the biggest companies in the United States. People who want to protect their money or bet on the gains or losses of the S&P 500 could buy or sell credit derivatives on the index.

Currency contracts don’t tell you how an index will do in the future.

Ways to Trade Index Futures

Some of the most popular index futures are based on stocks. When buyers buy these, they hedge their bets on the specific index named in the contract.

E-mini S&P 500 futures contracts are one-way traders buy in the S&P 500 index. Futures trades for the Dow Jones and the Nasdaq 100 Index are also possible. The E-mini Dow and E-mini Nasdaq-100 futures contracts are one type. The Micro E-mini Dow and Micro E-mini Nasdaq-100 are smaller versions of these contracts.

Outside of the U.S., you can trade futures for the Swiss Market Index and the DAX Stock Index, which comprise 30 prominent German companies—both trade on the Eurex. Hong Kong’s Hang Seng Index (HSI) futures let buyers bet on the main index of that market.

The contract price for different products may be based on different multiples. An E-mini S&P 500 futures contract trades on the Chicago Mercantile Exchange (CME) and is worth $50 times the value of the index. If the index trades at 3,400 points, the option is worth $170,000, which is 3,400 times $50.1

In September 2021, the CME took off the market the standard-sized S&P 500 index futures and options contracts. 2 These deals cost $250 times what the S&P 500 was worth. In other words, if the index moved by 3,400 points, the contract would be worth $850,000, which is 3,400 times $250.

Index Futures and Margin Rates

When a trade is made, the buyer of a futures contract doesn’t have to put up the whole contract amount. Instead, they only ask the buyer to keep a small part of the deal amount in their account. This first gap is what it’s called.

Prices for index futures can change a lot until the deal ends. Buyers must have the “maintenance margin” in their accounts—enough money to cover a possible loss. The maintenance cushion tells the bank how much money it needs to keep in the account to pay future claims.

The Financial Industry Regulatory Authority (FINRA) says the minimum account amount must be at least 25% of the total trade value. However, some brokerages will ask for more than 25%.3And if the trade’s value goes up before it expires; the seller can ask for more money to be put into the account. The name for this is a margin call.

It is important to remember that index futures contracts are deals that both the buyer and the seller must follow. Futures are not the same as options because a futures deal is an obligation. Conversely, a choice is a right that the owner may or may not use.

How Much You Can Make or Lose with Index Futures

The person who owns a benchmark futures contract agrees to buy an index at a specific price on a specific date. These credit derivatives usually settle every three months, in March, June, September, and December. There are also often several monthly contracts.

Futures on stocks and indexes are paid in cash. In other words, the base asset is not delivered at the end of the contract. The customer wins if the index price exceeds the agreed-upon price at expiration. The seller, called the “futures writer,” loses money. When things go the other way, the buyer loses money, and the seller gets money.

For instance, if the Dow ends September at 16,000, the person who owned a September futures contract worth 15,760 a year ago will have made money.

The gap between the entry and exit prices of the contract shows how much money you made. When you make a sale based on speculation, there is a chance that the market will move against you. As we already said, the trading account needs to meet margin requirements and could get a margin call to cover any possible losses. Traders need to know that market index prices can be affected by many things, such as macroeconomic conditions like economic growth and company earnings.

Index Futures to Protect Yourself

As a way to protect themselves against possible losses, portfolio managers often buy stock index futures. Sales of equity benchmark futures can help managers protect against the risk of falling stock prices if they have stakes in many stocks.

As a general rule, stocks move in the same way. The portfolio manager could sell or “short” a collateralized debt obligation contract if stock prices drop. If the market went down, the stocks in the portfolio would lose value, but the sold benchmark futures contracts would gain value, making up for the stock losses.

The fund manager could protect the stock against its downside risks or just some of them. The problem with hedging is that it cuts into income when it’s unnecessary. If the investor from the last part shorts index futures in September and the market goes up, the value of the commodity contract goes down. If the stock market increases, the hedge will cause losses that cancel out the portfolio’s gains.

Index Futures Trading and Bets

Speculation is a more advanced trade method that not all buyers should use. However, skilled traders often use index futures to guess how an index will move. Traders can bet on the direction of a group of assets by buying or selling index futures instead of buying individual stocks or assets.

If buyers wanted to copy the S&P 500 Index, they would have to buy all 500 stocks that comprise the index. You can bet on the direction of all 500 stocks instead of index futures. One contract has the same effect as holding all 500 stocks in the S&P 500.

Pros

• Index futures can protect you against drops in positions that are similar.
• Brokerage accounts only need a small amount of the contract’s value as a margin.
• Index futures let people guess how the index price will move.
• Markets that help companies lock in the costs of goods for the future

Cons

• Shoulder-to-shoulder or wrong-way swaps will hurt any gains in the portfolio.
• Brokers can ask for more money to keep the account’s balance amount the same.
• Index futures trading is a hazardous thing to do.
• Things that can’t be planned for could make the score move in the opposite direction of what is wanted.

Index futures contracts vs. commodity futures contracts

Futures contracts and stock index futures work differently because of how they are made. Traders can use these agreements to buy or sell a certain amount of a good at a specific price on a specific date. Most of the time, contracts are traded for real things like sugar, cotton, wheat, gold, crude oil, etc.

People usually trade commodity futures to protect themselves against changes in the underlying product’s price or to bet on those changes. People long in commodities futures contracts will have to take physical delivery if they haven’t closed their trade before the contract expires. This is different from index futures, which settle in cash.

Businesses often use commodity futures to lock in the prices of the raw materials they need to make their products.

Some examples of index futures

Here’s a made-up case to show how investors can guess with index futures. Let’s say an investor wants to bet on the S&P 500. The contract is worth $100,000 ($50 times 2,000), which they pay for when the index trades at 2,000 points. The price of E-mini S&P 500 futures is $50 times the value of the index.

Investors don’t have to pay 100% for index futures contracts; they only need to keep a small amount in a trading account.

In the first case, the S&P 500 Index drops to 1,900 points. The deal for futures is now worth $95,000, which is $50 times 1,900. $5,000 is lost by the owner.

Second case: The S&P 500 Index goes up to 2,100 points. The deal for futures is now worth $105,000, which is $50 times 2,100. The investment gets $5,000 back.

How do you buy and sell an index future?

Index futures are contracts that let you buy or sell stock market indexes at a specific date and time at an agreed-upon price. You can trade futures for the S&P 500, the Dow Jones, and the Nasdaq 100.

Also, you can trade futures for foreign market indexes like the FTSE 100 or the Hang Seng. You must open an account with a brokerage company to trade commodities options.

Again can trade the market you want once your account is open. You can also choose whether to go long (you think the price will go up) or short (you think the price will go down). If your deal is about to end, keep an eye on it.

Can an Index Future Be Used to Guess How the Market Will Do?

Index futures are usually seen as a bet, not a way to predict what will happen. When traders buy equity currency contracts, they bet or guess the index will move a certain way. Those who hold long positions bet that the index price will go up, while those who hold short positions bet that the price will go down. Markets can move in any way because of the many things that affect them. Because of this, there is no surefire way to predict the market, not even benchmark futures.

Is it riskier to trade index futures than stocks?

Index futures are about the same level of risk as stocks. Their prices depend on the prices of the measure they are based on. Speculative trades made by buyers who use borrowed money to make trades cause risk. But they are also used to hedge, which can lower the overall danger of an investor.

Conclusion

• Index futures are agreements to buy or sell a stock index at a specific price today. The agreements will be settled at a specific date in the future.
• At first, these contracts were only for big investors, but now anyone can sign them.
• Managers of portfolios use index futures to protect their stock positions in case stocks go down in value.
• Gamblers can also use index futures to bet on the market’s direction.
• The E-mini S&P 500, E-mini Nasdaq-100, and E-mini Dow are some of the most well-known index futures based on stocks. There are also commodity contracts on international markets.