What Are Stock Index Futures?

• Stock Index Futures are Highly Margined

  Stock index futures allow investors, in a single trade, to own a representative sample of the major stocks of the index. It is cheaper and more effective to purchase a stock index rather than a proportionate share of every stock in the index. Stock futures are purchased on margin or leveraged. That means that if the value of the contract is deemed to be $100,000 an investor would place a deposit of perhaps 20 percent. The investor is still liable for the remaining value whether the index rises or falls. Margin allows traders great amounts of leverage subject to tight regulatory conditions.

• The Mechanics of Stock Index Futures

  Futures have a contract expiration date that varies from one month to about 18 months. Arbitrageurs trade the very slight differences between the cash and futures markets that arise throughout the day. Futures positions must be closed by expiration day. If the investor wants to remain invested, the trader may purchase a new position in a later month.

• Investors Use Stock Futures to Speculate

  Generally, stock futures are used for speculation or hedging. Speculation refers to investing for profit by trading stock index future's contracts. The investor does not have to concern himself with credit risk when using stock index futures, only with market direction. In neither case can the stock index futures trader take physical delivery of the stock. At expiration date all outstanding stock index contracts can only be settled by cash.

• Measuring Risk and Reward in Trading Futures Contracts

  Stock futures resemble options trading in that they are both mathematically constructed. Fundamental analysis such as balance sheet and cash flow review is important, but for futures trading money management and technical analysis are more important. A daily change of just 2 percent in the value of a futures contract represents a 10 percent swing in value based on the cash margin requirement (the deposit) required at the time of the trade. Thus, it is important that traders and investors be right about the direction of the market. Technical analysis is more attuned to market direction.

• Investors Use Stock Futures to Hedge

  Hedging is often done through stock futures. Portfolio managers who believe that small caps will outperform growth stocks will buy the Russell 3000 index and sell the Russell 1000. Investors use stock indexes because they provide liquidity and diversification. Hedging is also used when investors fear a brief market downturn and sell futures contracts rather than try to sell their stock positions in an uncertain market.

• Contract Specifications Can Be Found on the Exchange of the Index

  Individuals can trade mini contracts representing one-10th of the value of a full contract. Not all indexes have mini contracts. They have become popular with day traders who minimize transaction costs and gain liquidity. Contract specifications can be found on the website of the exchange where the stock index is traded. Contract specifications consist of the expiration dates, the definition of what stocks appear in the index, the deposit required to trade the index, and the hours during which the exchange will be open for trading.

References & Resources

• Lind-Walcott Trading Platform
• Chicago Board of Trade Mini Contracts