Tour de Finance:
What are Stock Index Futures?

What are Stock Index Futures?

Stock index futures are contracts to buy or sell the value of a stock index at a specific price on a specific date in the future. For instance, the E-mini S&P 500 futures contract is a ‘mini’ contract of the much larger S&P 500 futures contract – which has a value of approximately $250,000. The E-mini contract is a fraction of the size of its big brother, which makes it much more accessible and appealing for smaller, non-institutional traders, or ‘retail’ traders.

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 of the underlying indexes. Financial professionals, such as pension and mutual funds managers, typically use 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. The retail trader can also take advantage, on a smaller scale, by utilizing stock index futures contracts to either hedge their portfolio or to speculate on the market.

Why Trade Stock Index Futures?

If in trading futures you purchase a stock 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) a stock index futures contract, you hope to gain if the price of the contract declines. The rapid price changes associated with stock indexes create continuous opportunities for the successful trader.

It can be more efficient for a trader who believes the market will decline to trade stock index futures instead of equity securities. This is because stock index futures trading involves just one transaction to get into the market and one to get out, while selling a basket of individual equity securities is likely to involve numerous transactions.

Click here to view the differences of trading stock index futures vs. stock indexes (equities).

Stock index futures closely follow the price movement of their respective index, typically referred to as the “underlying” or “cash” index. 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.

Benefits of Trading Stock Index Futures

  • A fast, cost-effective way to actively trade products that track the stock indexes and offer the equivalent of road market exposure to a variety of major stock indexes
  • Substantial liquidity in terms of large open interest, volume and tight bid/offer spreads
  • Online access available around the globe and virtually around-the-clock throughout the trading week
  • The ability to employ a variety of trading strategies, such as hedging strategies (to attempt to protect a portfolio against a declining market) and spreading strategies (to attempt to take advantage of the relative out-performance of one sector of the market versus another)
  • Potentially lower trading costs compared to trading a basket of equities

Trading Stock Index Futures vs. Stock Indexes (Equities)

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Stock Index Futures
Stock Indexes (Equities)
Type of broker
 Series 3 licensed commodity futures broker Series 7 licensed stock broker
Underlying
 Cash index Ownership of shares in a company
Settlement
 Mark-to-market daily T+3*
Margining
 Performance bond. 5-20% of contract value. Reg. T margin: put up 50%, borrow 50%. Interest charged on borrowed funds.
Risk
 Leverage can magnify gains as well as losses by several fold. Leverage can magnify gains as well as losses by two-fold, assuming Reg. T margins.
Short Selling
 No uptick rule. No borrowing of shares. No dividends on futures. Uptick rule.** Short seller borrows shares and must pay dividens to owner of shares (long).
Online Availability
 Yes Yes
Regulation
 Commodity Futures Trading Commission (CFTC) Securities and Exchange Commission (SEC)
Financial Safeguards
 CME Clearing House Securities Investor's Protection Corporation (SIPC).

*Date of trasaction plus three days.
**The 'uptick' rule states that before a Short Sale can be initiated a stock must trade on an 'uptick'.

To obtain a copy of the disclosure statement for security futures products, Click Here. Security futures products and futures trading are not suitable for all types of investors. There is a substantial risk of loss in trading futures and options.
 

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