What Are Index Futures? Definition, Types, and How to Profit

The downside of hedging is that this reduces profits if the hedge isn’t required. So, if an investor with a September futures contract shorts index futures and the market rises, the index futures would fall in value. The losses from the hedge would offset gains in the portfolio as the stock market rises. An index tracks the price of an asset or a group of assets, such as equities, commodities, and currencies. A futures contract is a derivative that obligates traders to buy or sell the underlying asset on a set day at a predetermined price.

Unlike index futures, which are cash-settled, long-position holders of commodity futures contracts will need to take physical delivery if the position has not been closed out ahead of expiry. Index futures contracts allow investors to make trades on various indices based on their predictions about the overall price movement of the particular index. Futures contracts involve margin, meaning investors can trade much larger amounts of money than their actual available capital. Before trading futures, ensure you understand how they work and that you can handle the volatility and potential losses they involve. While futures trading has expanded dramatically in the past the 5 major stock investing strategies for value investors decade or so, it’s still often a losing bet for inexperienced traders. Put simply, DJIA futures contracts enable traders and investors to bet on the direction in which they believe the index, representing the broader market, will move.

Investors seeking exposure to the DJIA can also purchase exchange-traded funds (ETFs) that track the index. If the farmer agrees, the contract has been made, and each party waits for January. No matter the price of soybeans in January, the price set is what the grocer pays. If you have little exposure to the futures market, you may, at first, feel perplexed by Dow Futures. Beware, though, that leverage cuts both ways, magnifying losses as well as gains.

If you expect the DJIA to go up, buy a futures contract; if you expect the index to decline, sell one short. Take a position in the futures contract trading month you want to trade—the one with the closest expiration date will be the most heavily traded. The difference between the entry and exit prices of the contract determines profits. As with any speculative trade, there are risks the market could move against the position. The trading account must meet margin requirements and could receive a margin call to cover any risk of further losses.

Index futures, which are also called stock or equity market index futures, work just like other futures contracts. They give investors the power and obligation to deliver the contract’s cash value based on an underlying index on a specified date at an agreed-upon price. Unless the exchange rate us dollar to japanese yen contract is unwound before expiration through an offsetting trade, the trader is obligated to deliver the cash value on expiry. This differs from other types of futures, like those involving commodities, where a party might be obligated to hand over the underlying asset at expiry, not cash. Investors generally trade commodity futures to hedge or speculate on the price of the underlying commodity.

1. No matter the price of soybeans in January, the price set is what the grocer pays.
2. Before trading futures, ensure you understand how they work and that you can handle the volatility and potential losses they involve.
3. Dow Futures contracts trade on an exchange, meaning that the exchange is who you deal with when you create your position (your price and contract) on the commodity.
4. A futures contract is a derivative that obligates traders to buy or sell the underlying asset on a set day at a predetermined price.
5. So, if an investor with a September futures contract shorts index futures and the market rises, the index futures would fall in value.

Hedging with futures, meant to offset risks in part of a portfolio, could lower your overall risk. Still, results can vary significantly based on market knowledge, experience, and the ability to manage leverage and diversification effectively. Speculation is a sophisticated trading strategy not suited for many investors. 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 buying or selling index futures.

Closing a Position

Market sentiment is fickle—if a company reports huge earnings, and the Dow Futures skyrocket, the odds are good that the stock market itself will rise as well. If an unexpected weather event shuts down major shipping lanes before the stock market opens, it could cause the Dow Futures to drop, because investors begin anticipating problems. This creates the possibility of stocks also falling once the opening bell rings.

Buying Futures With Leverage

Once your account is open, choose the index you want to trade and decide whether to go long (you believe the price will increase) or short (you think the price will decrease). So, you might buy a futures contract when it’s trading at 5,000 points, resulting in a contract value of $250,000 ($50 x 5,000). An index futures contract states the holder agrees to purchase an index at a particular price on a specified date. Index futures typically settle quarterly in March, June, September, and December. The Financial Industry Regulatory Authority requires a minimum of 25% of the total trade value as the minimum account balance, although some brokerages ask for more.

Index Futures and Margins

The E-mini, or mini-Dow, contract, as noted above, represents $5 per tick on the DJIA. The Micro E-mini is one-tenth the size of the E-mini, and represents 50 cents per point with a margin requirement of about $800, as of September 2023. The price of index futures tracks the value of the underlying index but won’t be precisely the same as it. For example, to replicate the S&P 500 Index, investors would need to buy all 500 stocks in the index. Instead, index futures can be used to bet on the direction of all 500 stocks, with one contract creating the same effect of owning and properly weighing the 500 stocks in the S&P 500.

As a result, a trader who believed the market were going to rally could simply acquire Dow Futures with a smaller amount of money and make a huge profit as a result of the leverage factor. Options are derivatives of the futures market, which have a market and exchange of their own. Options are purchased to give the holder the right—but not the obligation—to exercise the terms of the commodities deal. In a futures contract, both parties have an obligation to perform their part of the deal. corporate finance Futures contracts such as the E-mini Dow enable just about anyone to trade or invest in the Dow Jones Industrial Average (DJIA), the most iconic stock index in the world. The Dow tracks 30 blue-chip U.S. stocks from nine sectors, ranging from industrials to healthcare to consumer staples.

Futures Trading Basics

Dow Jones futures are simply futures contracts that can be purchased to hedge or speculate against components in the DJIA. The futures are instruments derived from the index known as E-mini Dow futures. The fund manager could hedge all the downside risks of the portfolio or only partially offset them.

A futures contract is a legally binding agreement between two parties in which they agree to buy or sell an underlying asset at a predetermined price in the future. And the value of the underlying asset—in this case, the Dow—will usually change in the meantime, creating the opportunity for profits or losses. As such, traders must have enough money in their accounts to cover a potential loss, which is called the maintenance margin. This sets the minimum amount of funds an account must hold to satisfy future claims. An index tracks and measures the price of a collection of assets, such as a group of stocks. Index futures are derivative financial contracts, meaning they derive their value from an underlying asset, in this case, the index.

For instance, traders can invest in the S&P 500 index by purchasing E-mini S&P 500 futures contracts. A trader can buy an E-mini Dow contract for about $5,500—and that futures contract is worth $5 for every point on the DJIA. So if you buy when the index itself is at 29,000, and sell when it hits 30,000, you’ve made $5,000 on the trade, nearly doubling your money. In addition to the front month, Dow futures are listed quarterly, with expirations in March, June, September, and December. These contracts are cash-settled, meaning that delivery is made in the equivalent value of the index rather than in the stocks that make up the index itself. By their nature, stock index futures work differently from commodity futures.

If Dow Futures are currently trading at 6,000, for example, a single futures contract would then have a market value of $60,000. For every $1 (or “point” as it is known on Wall Street) the DJIA fluctuates, a single Dow Futures contract has an increase or decrease of $10. The position you take on a trade is the purchase price you have agreed upon with the seller. Dow Futures contracts trade on an exchange, meaning that the exchange is who you deal with when you create your position (your price and contract) on the commodity. Because index futures don’t require investors to put up the full 100%, you need only to maintain a small percentage in your brokerage account.

As the value of the trade climbs before expiration, the broker can require that more funds be added to the account. Futures contracts don’t require the buyer to put up the entire value of the contract when entering a trade. Instead, buyers must keep just a fraction of the contract amount in their account. The Dow Jones futures use a multiplier of 10 (often called 10 to one leverage or 1,000% leverage).