Stock Index Futures: Definition and Examples
Stock index futures can be used to purchase or sell stocks at a specified price and on a future date.
Find out how stock index futures work and their pros and cons.
What are Stock Index Futures?
Futures of stock indexes bet on how equities will move with key stock market indicators.
Stock index futures are traded at different times throughout the day. These futures are traded even after the stock market closes. They can therefore be extremely active and cause rapid price changes as well as sales.
How Stock Index Futures work
A futures broker is usually used to trade stock index futures. A broker facilitates trades on both buy- and sell orders. Stock futures trade like stock market securities. A “buy” position allows you to profit from a rising stock exchange, while “sell” orders allow you to benefit from a falling stock marketplace.
The National Futures Association is a great place to start if you are looking for a broker who can help you trade stock futures. You should verify any futures trading fees or complaints against brokers. A broker should have a track record of producing fair, clean stock index futures trades.
All traders love the idea of making big profits. Futures can be risky because you could place too much money on market outcomes.
Pros and Cons of Stock Index Futures
Pros:
- Speculation on future prices without owning the stocks of the index covered by futures
- You could potentially make a lot of money with very little capital
Cons:
- If a trade goes south, leverage can lead to investors losing their entire investment.
- To fulfill possible margin calls, you will need cash in your margin accounts
Pros Explained
Futures have two main advantages: cost and potential for speculation.
- Speculation options: You have the ability to speculate on stock prices in the future and provide them with more leverage. You can trade securities 24/7 in highly-regulated markets.
- Trading costs: When you buy futures contracts for stock indexes, you pay much less than the list price of the stocks in the index. A $2480 investment per share for 100 shares in the S&P 500 Index would be $248,000. You would pay a lot less if you bought one S&P 500 futures contract or 100 shares of the index.
The Cons
Futures trading has its disadvantages. They are high-risk and require cash to be managed.
Leverage risk: One downside to index futures investing, is the high level of risk involved in buying and selling these contracts. When market conditions are not favorable, it is easy to become highly leveraged and lose all of your investment.
Margins and cash: There is an important aspect to remember when trading stock index futures. You must have cash in a margin account with a brokerage firm in order to participate in trades.
Your broker will contact you to replenish your margin account if you fail to do so. This is called a margin call. You run the risk of quickly building up debt to pay off your margin account if you don’t have enough money.
Margin calls have caused traders to lose their personal assets and get into deep debt.
Notable Events
Futures trading began in the United States in the 1800s, when farmers from the region met in Chicago to sell their wheat to dealers. The concept of commodities futures was born when parties exchanged future bushels of wheat, butter, and livestock. Sellers could set prices in advance, and buyers would know the final costs.
In 1997, stock index futures started trading on the Chicago Mercantile Exchange. CME continues to offer robust trading for both buyers and sellers who have a long-term perspective on stock-related financial investments.
Trading Stock Index Futures
Futures trading is possible with online stock brokerages if your account has margin and options privileges.
Stock index exchange-traded funds (ETFs) are another option. These funds offer stock futures access without the high risk associated with standalone stock market index vehicles.
Before you decide to invest in stock futures, it is a good idea to consult an investment advisor or other experienced financial professional. Objective investment advice can help you make more responsible and measured investment decisions.
The Key Takeaways
- Stock index futures can be used to purchase or sell stocks at a specified price and on a future date.
- These can be used to speculate on future price movements, but they are risky if the prices change too rapidly.
- ETFs can be used to invest in future stock index futures.
- It is a good idea to first consult with a professional.