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.

(For a more in-depth look at futures, see our Futures Fundamentals Tutorial.)

RELATED FAQS
  1. 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 >>
  2. How risky are futures?

    Understand how futures contracts are trading and learn what aspect of futures trading poses potentially greater risk than ... Read Answer >>
  3. How are futures used to hedge a position?

    Futures contracts are one of the most common derivatives used to hedge risk. A futures contract is as an arrangement between ... Read Answer >>
  4. How do I set a strike price for a future?

    Find out why futures contracts don't have set strike prices like options or other derivatives, even though price change limits ... Read Answer >>
  5. What does a futures contract cost?

    Learn about values of futures contracts and the initial margin a trader must place in an account to open a futures position, ... Read Answer >>
  6. How do I learn technical skills for trading commodities?

    Learn what resources are available to learn about trading commodities, and understand some of the differences between stocks ... Read Answer >>
Related Articles
  1. Active Trading Fundamentals

    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. Options & Futures

    20 Investments: Futures Contract

    What Is It? As the name implies, futures are contracts on commodities, currencies, and stock market indexes that attempt to predict the value of these securities at some date in the future. ...
  3. Mutual Funds & ETFs

    Introduction To Currency Futures

    The forex market is not the only way for investors and traders to participate in foreign exchange.
  4. Term

    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.
  5. Options & Futures

    Curious About Stock Index Futures? Read This First

    You've mastered investing in individual stocks...now what? If you like a challenge, consider stock index futures. Just be careful.
  6. Insurance

    Futures Fundamentals: Characteristics

    In the futures market, margin has a definition distinct from its definition in the stock market, where margin is the use of borrowed money to purchase securities. In the futures market, margin ...
  7. Options & Futures

    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 ...
  8. Options & Futures

    How The Price Of Stock Futures Is Calculated

    Any derivative that exists can be securitized into a future, though of course most investors deal with the stock variety. Here's how they're priced.
  9. Insurance

    Futures Fundamentals: Introduction

    A futures contract is a type of derivative instrument, or financial contract, in which two parties agree to transact a set of financial instruments or physical commodities for future delivery ...
  10. Options & Futures

    Beginner's Guide To Trading Futures: Considerations Prior to Trading Futures

    Prior to trading futures, there are several things to consider. Among these are which brokerage firm you wish to utilize; what types of futures you might want to trade; and what kinds of trades ...
RELATED TERMS
  1. Index Futures

    A futures contract on a stock or financial index. For each index ...
  2. Contract Unit

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

    Any board of trade designated to trade a specific options or ...
  4. Job Lot

    A futures contract with a minimum trading unit smaller than the ...
  5. Contract Size

    The deliverable quantity of commodities or financial instruments ...
  6. Against Actual

    An order between two traders looking to hedge their positions, ...
Hot Definitions
  1. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  2. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  3. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  4. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
  5. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
  6. Sharing Economy

    An economic model in which individuals are able to borrow or rent assets owned by someone else.
Trading Center