Index Futures

What are 'Index Futures'

Index futures are futures contracts on a stock or financial index. For each index, there may be a different multiple for determining the price of the futures contract.

For example, the S&P 500 Index is one of the most widely traded index futures contracts in the United States; stock portfolio managers who want to hedge risk over a certain period of time often use S&P 500 futures.

BREAKING DOWN 'Index Futures'

By shorting these contracts, stock portfolio managers can protect themselves from the downside price risk of the broader market. However, if this hedging strategy is used perfectly, the manager's portfolio will not participate in any gains on the index; instead, the portfolio will lock in gains equivalent to the risk-free rate of interest. Alternatively, stock portfolio managers can use index futures to increase their exposure to movements in a particular index, essentially leveraging their portfolios.

The underlying commodity associated with an index future is a particular stock index, which cannot be traded directly. This causes futures to be the main way stock indexes can be traded, functioning and trading in the same way as other investments on the futures market.

Since an index is comprised of stock from multiple companies, settlement cannot be handled through the transition of ownership of a particular stock certificate. Instead, most index futures are settled in the currency associated with the investment.

Popular Index Futures

Within the United States, some of the most popular index futures are the mini Dow Jones (YM) and the mini Nasdaq (NQ) on the Chicago Board of Trade, and the mini Russell 2000 (ER2) and mini S&P 500 (ES) on the Chicago Mercantile Exchange.

Index futures are also available in foreign markets. This includes the DAX and the SMI index futures in Europe, and the Hang Seng Index future in Asia.

Index Futures Contracts

An index futures contract states that the holder agrees to purchase an index at a particular price on a specified date in the future. If on that future date the price of the index is higher than the agreed-upon price in the contract, the holder has made a profit, and the seller suffers a loss. If the opposite is true, the holder suffers a loss, and the seller makes a profit.

Futures contracts are legally binding documents specifying the detailed agreement between the buyer and seller. It differs from an option in that a futures contract is considered an obligation, while an option is considered a right that may or may not be exercised.

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