WHAT ARE STOCK INDEX FUTURES?

Stock index futures are contracts to buy or sell the value of a specific stock index at a specific date in the future. Businesses and individual traders trade stock index futures for different reasons, but primarily to try to profit from or protect themselves from changes in the price underlying indexes. Financial professionals, such as pension and mutual fund managers, typically use CME index futures for managing risk and hedging portfolios against adverse price moves. Others, such as day traders or position traders, trade these products to speculate on the price fluctuations of the stock market.

Stock index futures closely follow the price movement of their respective indexes, typically referred to as the “underlying” or “cash” indexes. Intraday, monthly, and yearly correlations between cash indexes and futures are very close. On some occasions, the futures may diverge from the cash index for short periods of time, but market forces (such as arbitrage) usually work to bring these brief variances back into line.

If in trading futures you purchase an index futures contract, you hope to gain from future price increases when you offset your trade by selling the contract. Correspondingly, if you initially sell (i.e., selling short) an index futures contract, you hope to gain if the price of the contract declines. Remember though, if your forecast proves wrong, you risk loss. The rapid price changes associated with stock indexes and stock index futures create continuous opportunities for the successful trader. It can be more efficient, however, for a trader who believes the market will decline to trade stock index futures instead of equity securities. This is because a stock index futures trade involves just one transaction to get into the market and one to get out, while selling a basket of equity securities is likely to involve numerous transactions.