Stock index futures are legal agreements to buy or sell stocks on a future date and at a specific price.
Learn how stock index futures work, their pros and cons, and what they mean for you.
What Are Stock Index Futures?
Stock index futures are bets on the movement equities will take that track with key stock market indexes.
Stock index futures trade at different times of the day. They are often even traded after the stock markets close. As a result, they can be very active, leading to rapid price changes and sales.
How Stock Index Futures Work
Typically, stock index futures are traded with the help of a futures broker. The broker facilitates the trade on both buy and sell orders. Stock futures trade just like stock market securities, where a "buy" position lets you profit from a rising stock market, while "sell" orders let you benefit from a falling stock market.
If you're looking for a broker to help you trade stock futures, the National Futures Association is a good place to begin. It's vital to check any fees linked to futures trading or complaints lodged against brokers. You should find one with a clean track record of generating clean, fair stock index futures trades.
All traders like the prospect of cashing in on big returns. The problem with futures is that you might bet too much on future market outcomes even with little money down.
Pros and Cons of Stock Index Futures
Ability to speculate on future prices without having to own the stocks on the index covered by the futures
Could potentially make a large amount of money with little capital
Leverage can cause investors to lose their entire investment if the trade goes south
Cash is required in margin accounts to fulfill potential margin calls
The chief advantages of futures come down to cost and speculation potential:
- Speculation possibilities: You can speculate on future stock prices and give them more leverage. You have access to 24/7 securities trading in highly regulated markets and don't need to own the stocks on the index that the futures contract covers.
- Costs to trade: When you're buying stock index futures contracts, you’re paying much less than the listed price for the stocks on the index tracked by the futures contract. For example, a $2,480 per-share investment for 100 shares of the S&P 500 Index would cost $248,000. If you were to buy one S&P 500 futures contract (or 100 shares of the index), you'd pay quite a bit less.
The disadvantages of trading in futures are all about high risk and the necessity of holding cash:
- Leverage risks: One downside of index futures investing is the high risk of buying and selling these contracts. It's easy to wind up highly leveraged and lose your entire investment when market conditions go against you.
- Cash and margins: There is one vital aspect to think about when you trade stock index futures. To take part in trades, you're required to keep cash in a margin account at a brokerage firm. If you don't maintain your margin account, your broker will call you to restock it. This is known as a margin call. If you don't have the money to keep your margin account full, you face a real danger of building up high debt levels very fast to finance the account. Traders have lost their personal assets and gone very deep into debt in the past because of margin calls.
Futures trading in the United States dates back to the 1800s when regional farmers convened in Chicago to sell wheat to dealers. This evolved into commodities futures where parties traded for future bushels of wheat, livestock, and butter, among other items. Thus, sellers could lock in prices ahead of time, while buyers knew the costs they would eventually pay.
Stock index futures began trading on the Chicago Mercantile Exchange (CME) in 1997. The CME still offers robust trading for buyers and sellers with a long-term view of stock-related financial investments.
Trading Stock Index Futures
Online stock brokerages permit futures trading if you're approved for a margin and options privileges in your account.
You can also consider stock index exchange-traded funds (ETFs), which offer access to stock futures without the relatively high risk of standalone stock market index vehicles.
If you're determined to invest in stock index futures, consult with an investment advisor or another experienced financial professional before inking any deals. You’ll benefit from objective investment advice that may help steer you toward more measured and responsible investment decisions.
- Stock index futures are legal agreements to buy or sell stocks on a future date and at a specific price.
- They can allow investors to speculate on future prices, but are also risky if prices change too quickly.
- ETFs are one way to invest in stock index futures.
- It's advisable to consult with a professional first.