The futures markets trade contracts that call for the future delivery of commodities and financial instruments. One class of futures -- equity futures -- have contract values based on selected stock market indexes. Stock index futures offer an alternative way to trade the stock markets. Unique features of futures include a high level of leverage and around-the-clock trading.
A futures contract lives up to its name and is for the future delivery of a specified amount of the underlying asset. The futures of a specific asset -- such as a stock index -- will have a range of contract dates. Equity futures typically have a year's worth of quarterly contract dates plus several annual contract dates for traders who want to take a long-term position on a stock index. If an equity futures contract is held until its closing date, the final value of the futures contract will be cash settled based on the actual stock index value.
Types of Index Futures
Stock index futures trade against the major indexes including the Dow Jones industrial average, S&P 500 and the Nasdaq 100. There are also futures trading against selected small and mid-cap stock indexes. The popular stock indexes have futures contracts of different sizes. For example, the regular S&P 500 futures contract is worth 250 times the value of the index and the e-mini S&P 500 futures contract is valued at 50 times the S&P 500. The Dow Jones has futures of three different sizes trading against it.
Trading an Index Futures Contract
Stock index futures are traded through a commodity futures broker. A futures contract trade can be opened with either a buy or a sell order. Buy orders result in a long position, which profits from a rising stock index. Sell orders give a short position to profit from a declining index. The opening value of a futures trade is the price of the futures contract when the trade is placed, and profit or loss is calculated from that value. When a futures trade is placed, the trader must put up a margin amount set by the futures exchange. The trader's profit or loss on the trade adds to or subtracts from this margin deposit.
The margin deposit required to trade a stock index futures contract is a fraction of the future value providing the leverage of futures trading. For example, if the S&P 500 stock is at 1400, a futures contract is worth $350,000 and the current -- as of 2012 -- margin deposit amount is $19,250. A one point change in the stock index is a gain or loss of $250 per S&P 500 futures contract. Stock index futures trade 23 1/2 hours per day from Sunday afternoon until Friday afternoon. During the stock market day, the futures value closely matches the index value. Overnight the futures trades toward where traders believe the market will open the next morning.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.