What Are Stock Index Futures?
Definition & Examples of Stock Index Futures
Stock index futures are legal agreements to buy or sell stocks on a future date and at a specific price.
What Are Stock Index Futures?
The crystal ball of the financial markets, stock index futures are bets on the direction the equities will take that track with key stock market indexes.
Stock index futures trade at different times of the day, even after the traditional markets have closed. They can be very active, which can lead to fast-moving price changes and sales.
How Stock Index Futures Work
Typically, stock index futures are traded with the help of a futures broker, who facilitates the trade on both buy and sell orders. Just like traditional stock market securities trading, "buy" positions let investors profit from a rising stock market while "sell" orders enable investors to benefit from a declining stock market.
The National Futures Association is a good place to vet any potential brokers you’re considering to help you invest in stock index futures. It's vital to check fees linked to futures trading, complaints lodged against brokers, and their track records in generating clean, fair stock index futures trades.
While traders like the prospect of cashing in on big investment returns, with little money down, there are risks because investors can also bet too much on future market outcomes.
Pros and Cons of Stock Index Futures
Ability to speculate on future prices without having to own 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 comes down to cost and speculation potential:
- Speculation possibilities: Investors can speculate on future stock price performance, giving them more leverage, plus access to 24/7 securities trading in highly regulated markets—without actually owning the stock market index that the futures contract covers.
- Costs to trade: When buying stock index futures contracts linked to the above indices, you’re paying much less than the listed price for the actual stock market 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. By purchasing a single S&P 500 futures contract (or 100 shares of the index), however, futures investors pay significantly 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 level of risk inherent in buying and selling such 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 important distinction when investing in stock index futures. To participate, futures investors are required to keep cash in a margin account at a brokerage firm, which is required to cover steep losses on a futures trade. This occurrence is known as a margin call.
Futures trading In the United States dates back to the 1800s in the form of commodities futures where regional farmers convened in Chicago to sell wheat to dealers. That scenario evolved to include trades for future bushels of wheat, livestock, and butter, among other items. Sellers could lock in prices ahead of time, while buyers knew the costs they would eventually pay.
A century later, the stock index future began trading on the Chicago Mercantile Exchange in 1997 and it still offers robust trading opportunities 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.