What Are Stock Index Futures and How Do You Buy Them?
Investing in Stock Market Futures Offers Both Risk and Reward
Stock index futures are the crystal ball of the financial markets—they're bets on the direction of the equities market that track with key stock market indices. Stock futures date back to the 1840s when regional farmers convened in Chicago to sell wheat to dealers, in exchange for cold, hard cash—a practice that was dubbed as “spot” pricing.
That scenario evolved to include trades for future bushels of wheat, enabling sellers to lock in prices ahead of time, while buyers knew the costs they would eventually be paying.
A century and a half later, that “evolution of futures” led to the creation of the stock index futures contract, which began trading on the Chicago Mercantile Exchange in 1997 and still offers robust trading opportunities for buyers and sellers with a long-term view of stock-related financial investments.
Defining Stock Index Futures
Simply put, stock index futures are legal agreements to either purchase or sell stocks on a future date, at a specific price. This lets investors 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.
This tantalizes traders with the prospect of cashing in on big investment returns, with little money down. But this same practice holds the risk of working against stock index futures investors who bet too much on future market outcomes, wind up highly leveraged, and lose their entire investments when market conditions go against them.
There are a few reasons for and against using your money to invest in futures.
Can speculate on future prices without having to own the index covered by the futures
Can make a large amount of money with little capital
Using leverage, which can cause investors to lose their entire investment if the trade goes south
Investors are required to keep cash in a margin account to fulfill potential margin calls
What to Know When Investing in Stock Index Futures
Keep these data points in mind when investing in stock index futures:
Trading Matters: 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.
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 $100 per-share investment for 100 shares of the S&P 500 Index would cost $10,000. By purchasing a single S&P 500 futures contract (or 100 shares of the index), however, futures investors pay significantly less.
Cash Caveats: There is one important distinction when investing in stock index futures. To participate, futures investors are required to keep cash in what’s called a “margin” account, at a brokerage firm, which is required to cover steep losses on a futures trade--an occurrence known as a "margin call".
Recognize the Risk: The downside of index futures investing is the high level of risk inherent in buying and selling such contracts. The National Futures Association details the intricacies of leverage and risk linked to stock index futures (NFAFutures.org.) This resource is also a good place to vet any potential brokers you’re considering hiring 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 future trades.
Consider ETF’s: Consider stock index exchange-traded funds (ETFs), which offer access to stock futures, without the relatively high risk of stand-alone stock market index vehicles. For example, the benchmark SPDR S&P 500 Fund (SPY) and the iShares Russell 2000 Index ETF (IWM) both offer access to stock index futures.
Talk to an Expert
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 towards more measured and responsible investment decisions.