Investing indices futures
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Throughout her career, she has written and edited content for numerous consumer magazines and websites, crafted resumes and social media content for business owners, and created collateral for academia and nonprofits. Learn about our editorial policies What Are Index Futures? The term index futures refers to futures contracts that allow traders to buy or sell a contract that is derived from a financial index today to be settled at a future date.
Originally intended for institutional investors, index futures are now open to individual investors as well. They also use index futures to hedge their equity positions against losses. Key Takeaways Index futures are contracts to buy or sell a financial index at a set price today, to be settled at a date in the future. These contracts were originally meant solely for institutional investors but are now open to anyone. Portfolio managers use index futures to hedge their equity positions against a loss in stocks.
Speculators can also use index futures to bet on the market's direction. International markets also have index futures. Understanding Index Futures An index tracks the price of an asset or a group of assets, such as equities, commodities, and currencies. A futures contract is a type of derivative that obligates traders to buy or sell the underlying asset on a set day at a predetermined price.
An index future, therefore, is a legal contract that obligates traders to buy or sell a contract that is derived from a stock market index by a certain date at a predetermined price. Index futures, which are also called stock or equity market index futures, function just like any other futures contract. They give investors the power and obligation to deliver the cash value of the contract based on an underlying index at a specified future date at an agreed-upon price.
Unless the contract is unwound before expiration through an offsetting trade, the trader is obligated to deliver the cash value on expiry. Traders use index futures to hedge or speculate against future price changes in the underlying equity index. Index futures do not predict future index performance. Types of Index Futures Some of the most popular index futures are based on equities, which means investors hedge their bets on the individual index named in the contract.
Investors can also trade futures for the Dow Jones and Nasdaq Index. Outside of the U. Products may use different multiples to determine the contract price. Index Futures and Margins Futures contracts don't require the buyer to put up the entire value of the contract when entering a trade.
Instead, they only require the buyer to maintain a fraction of the contract amount in their account. This is called the initial margin. Index futures prices can fluctuate significantly until the contract expires. Therefore, traders must have enough money in their accounts to cover a potential loss, which is called the maintenance margin.
The maintenance margin sets the minimum amount of funds an account must hold to satisfy any future claims. And as the value of the trade climbs before expiration, the broker can demand additional funds be deposited into the account. This is called a margin call. It's important to note that index futures contracts are legally binding agreements between the buyer and seller.
Futures differ from an option because a futures contract is considered an obligation. An option, on the other hand, is considered a right the holder may or may not exercise. Profits and Losses from Index Futures An index futures contract states the holder agrees to purchase an index at a particular price on a specified future date.
Index futures typically settle quarterly in March, June, September, and December. There are usually several annual contracts as well. Equity index futures are cash-settled. This means that there's no delivery of the underlying asset at the end of the contract. If the price of the index is higher than the agreed-upon contract price at the expiry date, the buyer makes a profit while the seller who is known as the future writer suffers a loss.
In the opposite scenario, the buyer suffers a loss while the seller makes a profit. For example, if the Dow closes at 16, at the end of September, the holder with a September futures contract one year earlier at 15, ends up reaping a profit.
These can be on the same underlying but using different expiration dates, or on futures in two closely-related products like crude oil and gasoline. Technical analysis is a trading discipline employed to evaluate investments and identify trading opportunities by analyzing statistical trends gathered from trading activity, such as price movement and volume. Contract Specifications Before trading futures, investors need to know several key elements about futures contracts to help determine position size and manage risk.
These include contract size, contract value, and tick size. Contract Size As its name suggests, contract size refers to the deliverable quality of the asset that underlies the futures contract. Contract Value Investors calculate the contract value by simply multiplying the contract size by the current price. Tick Size Tick size refers to the minimum price change of a futures contract. In other words, the smallest amount that the price of a particular contract can fluctuate.
Futures Markets You Can Trade in Futures contracts are listed on several different products comprising many different asset classes. Among the most popular include: Equity indexes: e. Investors can trade futures on stock indexes, energy, currencies, cryptocurrencies, interest rates, grains, forestry, and livestock.
Advantages include leverage, diversification, trading after hours, and hedging. Disadvantages include over-leverage and managing expiry dates. Traders should select a futures trading platform that is intuitive to use, offers multiple order types, and has competitive fees and commissions. When developing a futures trading plan, traders should include entry and exit strategies and basic risk management rules.
The Bottom Line Futures are derivative contracts that let you speculate on the future price of some asset or commodity, or to let you hedge against existing positions. Because they utilize leverage, futures can amplify your bets, making for larger returns, but also larger losses. Futures also have expiration dates, so you need to be careful to roll over or close out positions so not to be stuck with physical delivery of unwanted commodities.
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Investors can also trade futures for the Dow Jones and Nasdaq Index. Outside of the U. Products may use different multiples to determine the contract price. Index Futures and Margins Futures contracts don't require the buyer to put up the entire value of the contract when entering a trade. Instead, they only require the buyer to maintain a fraction of the contract amount in their account. This is called the initial margin.
Index futures prices can fluctuate significantly until the contract expires. Therefore, traders must have enough money in their accounts to cover a potential loss, which is called the maintenance margin. The maintenance margin sets the minimum amount of funds an account must hold to satisfy any future claims. And as the value of the trade climbs before expiration, the broker can demand additional funds be deposited into the account.
This is called a margin call. It's important to note that index futures contracts are legally binding agreements between the buyer and seller. Futures differ from an option because a futures contract is considered an obligation. An option, on the other hand, is considered a right the holder may or may not exercise. Profits and Losses from Index Futures An index futures contract states the holder agrees to purchase an index at a particular price on a specified future date. Index futures typically settle quarterly in March, June, September, and December.
There are usually several annual contracts as well. Equity index futures are cash-settled. This means that there's no delivery of the underlying asset at the end of the contract. If the price of the index is higher than the agreed-upon contract price at the expiry date, the buyer makes a profit while the seller who is known as the future writer suffers a loss. In the opposite scenario, the buyer suffers a loss while the seller makes a profit.
For example, if the Dow closes at 16, at the end of September, the holder with a September futures contract one year earlier at 15, ends up reaping a profit. Profits are determined by the difference between the entry and exit prices of the contract. As with any speculative trade, there are risks the market could move against the position.
As mentioned earlier, the trading account must meet margin requirements and could receive a margin call to cover any risk of further losses. The trader must understand that many factors can drive market index prices, including macroeconomic conditions such as economic growth and corporate earnings.
Index Futures for Hedging Portfolio managers often buy equity index futures as a hedge against potential losses. If the manager has positions in a large number of stocks, index futures can help hedge the risk of declining stock prices by selling equity index futures.
Since many stocks tend to move in the same general direction, the portfolio manager could sell or short an index futures contract in case stocks prices decline. In the event of a market downturn, the stocks within the portfolio would fall in value, but the sold index futures contracts would gain in value, offsetting the losses from the stocks.
The fund manager could hedge all of the downside risks of the portfolio, or only partially offset it. The downside of hedging is that this reduces profits if the hedge isn't required. So if the investor from the previous section with a September futures contract shorts index futures and the market rises, the index futures decline in value. The losses from the hedge would offset gains in the portfolio as the stock market rises.
Speculation on Index Futures Speculation is an advanced trading strategy that is not suited for many investors. However, experienced traders tend to use index futures to speculate on the direction of an index. Instead of buying individual stocks or assets, a trader can bet on the direction of a group of assets by purchasing or selling index futures. Pros Index futures can hedge against declines in similar holdings Brokerage accounts require only a fraction of the contract's value held as a margin Index futures allow for speculation on the index price movement Helps businesses lock in commodity prices for commodity futures Cons Unnecessary or wrong direction hedges will damage any portfolio gains Brokers can demand additional funds to maintain the account's margin amount Index futures speculation is a high-risk undertaking Unforeseen factors may cause the index to move opposite from the desired direction Index Futures vs.
Commodities Futures Contracts By their nature, stock index futures operate differently than futures contracts. These contracts allow traders to buy or sell a specified amount of a commodity at an agreed-upon price on an agreed-upon date in the future. Contracts are normally exchanged for tangible goods such as cotton, soybeans, sugar, crude oil, gold, and what. You will need to request and be granted approval to begin trading these markets. Developing a Futures Trading Plan As with trading stocks or other financial assets, it's important that investors develop a plan for trading futures that outlines entry and exit strategies as well as risk management rules.
For example, if a trader uses technical analysis to locate entries, they may decide to open a long futures trade on a golden cross signal—when the day simple moving average SMA crosses above the day simple moving average. Alternatively, a futures trading plan centered around fundamental analysis might generate buy or sell signals based on crop or energy inventory reports. For instance, a trader may short an oil futures contract if weekly oil inventories grow at a faster pace than analysts had expected.
Of course, some traders may incorporate both technical and fundamental analysis into their futures trading plan. In general, there are three futures trading plans: Long: buy futures and profit when the prices increase Short: sell futures contracts and profit when the prices decrease Spread: simultaneously buy different futures contracts and profit when the relative price difference widens or narrows.
These can be on the same underlying but using different expiration dates, or on futures in two closely-related products like crude oil and gasoline. Technical analysis is a trading discipline employed to evaluate investments and identify trading opportunities by analyzing statistical trends gathered from trading activity, such as price movement and volume.
Contract Specifications Before trading futures, investors need to know several key elements about futures contracts to help determine position size and manage risk. These include contract size, contract value, and tick size. Contract Size As its name suggests, contract size refers to the deliverable quality of the asset that underlies the futures contract.
Contract Value Investors calculate the contract value by simply multiplying the contract size by the current price. Tick Size Tick size refers to the minimum price change of a futures contract. In other words, the smallest amount that the price of a particular contract can fluctuate.
Futures Markets You Can Trade in Futures contracts are listed on several different products comprising many different asset classes. Among the most popular include: Equity indexes: e. Investors can trade futures on stock indexes, energy, currencies, cryptocurrencies, interest rates, grains, forestry, and livestock.