Understanding Stock Index Futures: A Comprehensive Guide

Stock index futures, also referred to as equity index futures or just index futures, are futures contractsFutures ContractA futures contract is an agreement to buy or sell an underlying asset at a later date for a predetermined price. It’s also known as a derivative because future contracts derive their value from an underlying asset. Investors may purchase the right to buy or sell the underlying asset at a later date for a predetermined price. based on a stock index. Futures contracts are an agreement to buy or sell the value of the underlying assetAsset ClassAn asset class is a group of similar investment vehicles. They are typically traded in the same financial markets and subject to the same rules and regulations. at a specific price on a specific date. In this case, the underlying asset is tied to a stock index.

Index futures, however, are not delivered at the expiration date. They are settled in cash on a daily basis, which means that investors and traders pay or collect the difference in value daily. Index futures can be used for a few reasons, often by traders speculating on how the index or market will move, or by investors looking to hedge their position against potential future losses.

Quick Summary of Points

• Stock index futures are a purely cash-settled futures contract based on a stock index
• Index futures are settled daily and traded by futures brokers on stock exchanges
• Index futures are used for a number of reasons such as speculating, hedging, and spread trading
• Index futures can be used as strong leading indicators of market sentiment

How are Stock Index Futures Traded and Settled?

Stock index futures are similar to other futures contracts; however, the underlying asset is a stock index. With any futures contract, there is the agreement to pay a specific price on a set date (the expiration date). Index futures are purely cash-settled since it is not possible to physically deliver an index, and the settlements happen daily, on a mark-to-market basis.

Index futures are traded through futures brokers on stock exchangesStock ExchangeA stock exchange is a marketplace where securities, such as stocks and bonds, are bought and sold. Stock exchanges allow companies to raise capital and investors to make informed decisions using real-time price information. Exchanges can be a physical location or an electronic trading platform., and a futures contract can be made through a buy or sell orderTrade OrderPlacing a trade order seems intuitive – a “buy” button to initiate a trade and a “sell” button to close a trade.. A long positionLong and Short PositionsIn investing, long and short positions represent directional bets by investors that a security will either go up (when long) or down (when short). In the trading of assets, an investor can take two types of positions: long and short. An investor can either buy an asset (going long), or sell it (going short). is taken when a buy order is initiated, and a short position is initiated through a sell order. Like other futures contracts, a minimum amount, known as the initial margin is required to take the position. A maintenance marginMaintenance MarginMaintenance margin is the total amount of capital that must remain in an investment account in order to hold an investment or trading position and avoid a is also set, meaning the value must not drop past a certain point or else a margin call will be initiated. A trader will then need to deposit funds to meet this margin.

What are Stock Index Futures Used For?

Stock index futures are used for a number of reasons. The most common reason is from traders who are speculating on the direction the market will move in the future. Similarly to speculation on other assets, if a trader takes a bullish stance on the market and believes that the index will increase in value, then they may buy the stock index futures. Alternatively, if they have a bearish stance on the market the index is focused on, they may shortLong and Short PositionsIn investing, long and short positions represent directional bets by investors that a security will either go up (when long) or down (when short). In the trading of assets, an investor can take two types of positions: long and short. An investor can either buy an asset (going long), or sell it (going short). the index futures contract.

The assessment of index futures can be an important leading indicator of market sentiment. A high volume of long positions being taken on an index could mean that many traders are bullish on the market and believe the market the index is based on will increase in value.

Index futures can also be used for hedging purposes. If an investor is holding a portfolio that is similar or reflective of an index, buying or selling index futures can be used to offset potential losses their portfolio may face. In most cases, the portfolio will not be fully positively or negatively correlated with the index, so using index futures will not lead to a fully hedged position.

One other way index futures are used is as a spread or relative value trading tool. This is a position that involves taking a long and short position on index futures. This trade is done with a focus on the spread or the difference in the prices of the related securities. The trade will attempt to net a profit from the widening or narrowing of these prices, rather than a change of the index as a whole.

What are Some Widely Traded Stock Index Futures?

Index futures are traded for all major stock indices. They include the Dow Jones, S&P, Nasdaq, FTSE, DAX, and the many other stock indices that exist. There are also index futures that exist to increase accessibility by requiring less capital.

For example, the E-Mini S&P is an index futures contract traded on the Chicago Mercantile Exchange’s Globex platform and uses the S&P 500 as an underlying asset. It was introduced in 1997 when the S&P contract at the time was 500 times the index. The amount was too much for many traders, so the E-Mini S&P was introduced. The index futures contract is only 50 times the value of the S&P 500.

Additional Resources

Thank you for reading CFI’s article on stock index futures. If you would like to learn more about related concepts, check out CFI’s other resources:

• Futures ContractsFutures ContractA futures contract is an agreement to buy or sell an underlying asset at a later date for a predetermined price. It’s also known as a derivative because future contracts derive their value from an underlying asset. Investors may purchase the right to buy or sell the underlying asset at a later date for a predetermined price.
• HedgingHedgingHedging is a financial strategy that should be understood and used by investors because of the advantages it offers. As an investment, it protects an individual’s finances from being exposed to a risky situation that may lead to loss of value.
• SpeculationSpeculationSpeculation is the buying of an asset or financial instrument with the hope that the price of the asset or financial instrument will increase in the future.
• Bullish and BearishBullish and BearishProfessionals in corporate finance regularly refer to markets as being bullish and bearish based on positive or negative price movements.  A bear market is typically considered to exist when there has been a price decline of 20% or more from the peak, and a bull market is considered to be a 20% recovery from a market bottom.