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.
In the United States, stock futures date back to the 1800s with commodities futures when regional farmers convened in Chicago to sell wheat to dealers. That scenario evolved to include trades for future bushels of wheat, livestock, or butter, among other items. Sellers could 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.
Futures are also known as "derivatives," and are speculative, without any actual delivery of a physical product.
Here's what you need to know about stock index futures, and how to purchase them yourself.
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 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.
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.
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 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".
How Do You Buy Futures?
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.
Online stock brokerages also 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 stand-alone stock market index vehicles.
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.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.