Trading Stock Indexes Using Futures and Options Markets
What an Index is and how to chart and trade it
Experienced traders are aware of the main US, European, and Asian stock indexes, because these are the indexes that are reported in the news. Examples of these indexes include the S&P 500, Dow Jones Industrial Average, FTSE 100, Nikkei 225, CAC 40 and DAX.
While most traders have likely heard of or monitor these indexes, many new traders don't know how the stock indexes are traded, and often assume that they are traded like individual stocks.
The stock indexes cannot actually be traded directly, and are available for information only (as a way to track the performance of a group of stocks). Market data is available for the stock indexes, and they can be charted like any other market, but there is no way to make either a long or short trade on the actual stock indexes. But other financial products, like futures and options contracts, can be used to trade the movements of stock indexes.
What Is a Stock Index?
A stock index is a sampling or collection of stocks that gives an overview of how a specific part of the stock market is performing. For example, a technology stock index will contain several or all technology stocks. The index then moves with the overall performance of the stocks that it holds within it. This index can then be quickly used to monitor how technology stocks are performing currently and over time.
Indexes are popular because they provide information for a basket of stocks, and not just one. Therefore, they are good analysis tool, as well a good trading tool. As mentioned, they can't be traded directly, but there are products that allow traders to participate in the movements of stock indexes. The S&P 500 is a very popular index among individual and institutional traders, because it provides access to 500 stocks with a single futures or options contract transaction.
Futures and Options Markets
Whenever we hear a trader mention that they are long on the NASDAQ 100, or short on the S&P 500, they are not actually long or short on the NASDAQ 100 or S&P 500 indexes. They are actually long or short on a futures or options market, such as the NQ futures market or the SPXW options market.
Futures and options that are based upon a stock index are known as derivatives markets, because they are derived from the underlying stock index (underlying because the futures or options contract's value is based on the movements of the index it is based on). There are futures and options markets available for all of the popular stock indexes. Stock index futures and options are some of the most popular markets for short term and longer term traders alike.
Charting the Stock Indexes
Futures and options markets usually move in synchronization with their underlying stock indexes (when the CAC 40 stock index moves down, the CAC 40 futures market moves down). It is therefore possible to chart the stock indexes while trading the futures or options markets. That said, the futures contracts can also be charted and analyzed.
There are some advantages to charting the stock indexes instead of the futures or options markets. For example, the stock indexes are continuous markets (they do not expire like futures and options contracts do), so traders do not need to update their charting software to a new contract every three months (or monthly depending upon the market in question). Also, the options markets are difficult to chart because they consist of many equally active contracts (with different prices), so charting the stock indexes instead allows a trader to analyze multiple options contracts using a single chart.
If you do decide to chart the stock indexes instead of the futures or options markets, note that you still need to update your trading software (your order entry software) to use the appropriate futures or options contract, when trading, otherwise you may find yourself trying to trade an expired contract and wondering why it isn't working.
Most charting software has a box where you input the symbol you want to chart. If you start typing the name of the index, the index as well as futures or options related to it, will often appear in a drop-down menu. Start typing S&P 500, and you may see SPX, which is a common symbol on most charting platforms for the S&P 500 index (shown on attached chart, along with S&P 500 E-Mini Futures). You may also see varying futures or options products, and you can select them from the list to see a chart of those.
TradingView.com is a free charting site that provides index and futures charting (along with other products). Type in the name of an index, and then select whether you want to view indexes or futures from the drop-down list.
Final Word on Trading Stock Indexes
Stock indexes are a popular trading vehicle, but they can't be traded directly. An index is simply a collection of stocks (or other asset) that moves according to the stocks held within it. Traders can analyze both the index and the futures/options contract they are looking to trade. Indexes don't expire, but futures and options contracts do, so traders need to make sure they are trading the appropriate contract.