Simply put Index futures are futures contracts on a stock or financial index. They are cash settled contracts and the majority have quarterly expiration dates scheduled for the months of March, June, September, and December.It is important to understand here that index futures can either be based on the broader performance of an index or on a single stock,in this guide we will be focusing on the former type of Index futures.
Equity indexes are also offered in different sizes to accommodate for different trading needs. For example the E-mini S&P 500 futures contract, which are one-fifth the size of standard S&P 500 futures. Popularly traded index futures include S&P 500 futures, NASDAQ 100 E-mini,Dow industrial 30E-Mini and Russell 2000 Mini.
Short-term trading
As a form of derivative, futures can fit into your overall trading strategy. In volatility trading, for instance, the aim is to take small but regular profits from a volatile market.
Hedging against losses
If you have a portfolio of shares, you can limit your exposure to unwanted risk by opening an opposite position as an index future. So if you had a number of long shares positions, you could take a short position on the relevant index future. This would help you to offset any losses if your shares moved against you.
Investing
Being leveraged products, stock index futures give you exposure to a stock market or sector as a whole for a much smaller amount of up-front capital, and without having to purchase the individual constituent shares directly.
A variety of factors can affect Index futures including:
Industry performance
Often, the stock price of the companies in the same industry will move in tandem with each other. This is because market conditions generally affect the companies in the same industry the same way. Therefore this can greatly affect index futures, especially for indices heavily weighted in a particular sector.
Global events and Political news
Changes around the world can strongly affect indices and index futures. For example, a rise in energy costs can severely impact certain industries, for example airline industry. An act of terrorism can also lead to a downturn in economic activity, which affects index futures.If a new government comes into power, it may decide to make new policies. They may lead to changes in inflation and interest rates, which in turn may affect Index futures.
Company news and performance
A variety of corporate news can affect performance,especially those about companies holding higher weighting in a particular index.This news can include:
Outright bull/bear directional trades
This trading strategies is based on the investor’s assessment of the broad market. Directional trading can mean a basic strategy of going long if the market or security is perceived as heading higher, or taking short positions if the direction is downward.
Index spreads
A spread is the simultaneous purchase and sale of two futures contracts. An index spread is a common and effective trading strategy.The strategy is designed to express the relative value between index contracts rather than an outright market direction bias.
Brexit Referendum.
The Brexit referendum was an important global event with repercussions dramatically affecting the European Union and with it the global economy. Let's look at how it affected the FTSE 100 index (an Index future available for trading on the CME group) days before and after the referendum.
About the FTSE 100 index.
The FTSE 100 index is representative of approximately 80% of the market capitalization of the London stock exchange. It is weighted by market capitalization meaning that larger companies comprise a greater portion of the index. The Index is considered an indicator of prosperity among qualifying United Kingdom companies and the economy in general.
Thursday June 23 2016
On June 23 the polling day for the EU referendum occurred as british voters headed to the pools to cast their vote.
From the 20th to the 23rd, as the polling day approached the index actually went up by 2.16%.
However on the day of polling itself, the daily news showed another picture.
On Friday June 24th 2016 when the national declaration of referendum results occurred, the index dropped by 3.15% in the span of a day and then finally dropping by 5.62% by 27th June.
Surprisingly however, by 1st July 2016 the index was up by 9.96%:
With headlines for 1st July 2016 showing:
What this example makes clear is that the impact of any important political event for an index can be volatile and unpredictable to say the least.Therefore it is important to be critical of any broad market assessments and prepare exit strategies such as the use of a spread to minimize losses.
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