A:

Every morning before North American stock exchanges begin trading, TV programs and websites providing financial information will give the quotes for the S&P, Dow and Nasdaq futures contract. The quoted price movements of the futures contracts in early trading is used by some traders as a gauge for how the overall exchanges will perform at market open and over the trading day. If the index future is trading higher before the market opens, it generally means that the actual index will trade up in the early part of the day. This is because the index futures are closely tied to the actual indexes. These futures contracts mirror the underlying index and act as a precursor of the actual exchange index's direction.

A futures contract represents a legally binding agreement between two parties to pay or receive the difference between the predicted underlying price set when entering into the contract and the actual price of the underlying when the contract expires. Index futures trade with a multiplier that inflates the value of the contract to add leverage to the trade. The multiplier for the Dow is 10, for the Nasdaq it is 100 and it is 250 for the S&P.

For example, if a Dow Jones Index future is trading at 10,000, this means that if an investor purchased one futures contract, it would be worth $100,000. What this really means for the investor is that every one-point change in the Dow will cause a $10 change in real terms for the investor. If the Dow falls 100 points, the holder of the contract on the long side will lose $1,000.

Futures contracts are marked to market, meaning the change in value to the investor is shown in the investor's account at the end of each trading day until expiration. If the Dow falls 100 points in one trading day, at the end of the day, $1,000 will be taken out of the futures contract purchaser's account and placed into the seller's account. Because the index and the futures contract are so closely related both in price movement and value change, index futures are used to gauge the direction of the market.

For example, when the futures contracts on the S&P 500 trade higher, it means futures investors believe the actual exchange index will also trade higher once the markets open. DJIA futures contracts begin trading on the Chicago Board of Trade at 8:20am EST, just over an hour before the stock market opens for trading. The S&P 500 and Nasdaq 100 futures both open at 8:30am EST and trade on the Chicago Mercantile Exchange.

Major events and breaking news can occur during this one-hour window before the stock market opens; this news usually gets priced into the futures contracts, fluctuating like a normal index. This allows investors to use the futures prices to get a generalized view of market sentiment, and may help to position certain trading strategies before equity markets open.

RELATED FAQS
  1. How do the investment risks differ between options and futures?

    Learn what differences exist between futures and options contracts and how each can be used to hedge against investment risk ... Read Answer >>
  2. How do S&P 500 futures work?

    Learn about the mechanics of S&P 500 futures contracts, a type of stock index future introduced by the Chicago Mercantile ... Read Answer >>
  3. What types of futures contracts are typically sold on an exchange?

    Explore the wide variety of available futures contracts traded on exchanges, which range from agricultural commodities to ... Read Answer >>
  4. What is the difference between forward and futures contracts?

    Fundamentally, forward and futures contracts have the same function: both types of contracts allow people to buy or sell ... Read Answer >>
  5. How can I calculate the notional value of a futures contract?

    Learn how the notional value of a futures contract is calculated, and how futures are different from stock since they have ... Read Answer >>
Related Articles
  1. Trading

    How to Trade Dow Jones Future Contracts

    Learn about the Dow Jones Index futures contracts available and obtain step-by-step instruction on how to trade the stock index futures.
  2. Trading

    The Difference Between Forwards and Futures

    Both forward and futures contracts allow investors to buy or sell an asset at a specific time and price.
  3. Trading

    Using Index Futures To Predict The Future

    Want to know whether the stock market will open up or down? Check out the index futures.
  4. Investing

    A Quick Guide for Futures Quotes

    Here is a quick guide to futures quotes.
  5. Investing

    How to Trade Futures Contracts

    Futures is short for Futures Contracts, which are contracts between a buyer and seller of an asset who agree to exchange goods and money at a future date, but at a price and quantity determined ...
RELATED TERMS
  1. Contract Unit

    The actual amount of the underlying asset represented by a single ...
  2. Contract Market

    Any board of trade designated to trade a specific options or ...
  3. Futures Contract

    A contractual agreement, generally made on the trading floor ...
  4. Index Futures

    A futures contract on a stock or financial index. For each index ...
  5. Limit Move

    The largest amount of change that the price of a commodity futures ...
  6. Futures Exchange

    Traditionally, a term referring to a central marketplace where ...
Hot Definitions
  1. Book Value

    1. The value at which an asset is carried on a balance sheet. To calculate, take the cost of an asset minus the accumulated ...
  2. Dividend Yield

    A financial ratio that shows how much a company pays out in dividends each year relative to its share price.
  3. Fixed-Income Security

    An investment that provides a return in the form of fixed periodic payments and the eventual return of principal at maturity. ...
  4. Free Cash Flow - FCF

    A measure of financial performance calculated as operating cash flow minus capital expenditures. Free cash flow (FCF) represents ...
  5. Leverage Ratio

    Any ratio used to calculate the financial leverage of a company to get an idea of the company's methods of financing or to ...
  6. Two And Twenty

    A type of compensation structure that hedge fund managers typically employ in which part of compensation is performance based. ...
Trading Center