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What are Index Futures?

Index futures are contracts that allow a trader to purchase or sell a financial index today and have it resolved at a later date. Traders speculate on the price direction of an index, such as the S&P 500, using index futures. Index futures are also used by investors and investment managers to protect their stock investments from losses.

How do Index Futures Work?

Index futures, like all futures contracts, provide the trader or investor the power and responsibility to deliver the contract's cash value based on an underlying index at a future date. The trader is bound to provide the cash value on expiry unless the contract is unwound before expiration by an offsetting deal.

An index is a measurement of the price of a single item or a collection of assets. Index futures are derivatives, which means they are based on an underlying asset (the index). Traders utilize these products to trade a wide range of assets, including stocks, commodities, and currencies. To bet on the index's appreciation or depreciation, an investor could buy or sell index futures on the S&P 500.

How to Trade Index Futures?

In index futures investing or trading, the buyer and seller lock purchase and sell bids. Both parties agree to close their holdings lawfully at a specific price and on a specific date. Traders' buy and sell orders are placed by a futures broker on their behalf. The next step is to create a long and short position for buy and sell orders, with initial and maintenance margins.

The payment of futures contracts is entirely based on cash. On the expiration date, the seller and buyer can also pay and receive the difference in the agreed-upon contract price in cash. Simply said, a higher price results in a profit for the buyer, while a lower price results in a loss for the seller.

Types of Index Futures

Index futures are of several types, and they are mentioned below:

Nifty 50: 50 underlying securities make up the BSE's Sensitive Index or Sensex.

Nifty IT: Shares of information technology make up the underlying assets. The fortunes of these futures would depend on the performance of the overall sector.

S&P BSE Sensex: 30 underlying securities make up the BSE's Sensitive Index or Sensex.

Nifty Bank: Bank shares make up the index, so how the Nifty Bank futures would perform would depend on how well the banks are doing.

S&P BSE Bankex: The futures have banking stocks listed on the Sensex.

S&P BSE Sensex 50: This index is inclusive of 50 stocks instead of the 30 that make up the Sensex.

S&P BSE Bharat 22 Index: This index is made up of 22 central public sector enterprises.

Others: You could also trade in these futures from foreign stock exchanges.

Importance of the Index Futures

Due to a lack of cash to make large stock purchases, futures contracts are one of the most effective trading options. It's a derivative-based investment that allows traders to spend less while earning more. Furthermore, there are two methods for using equities or stock index futures:

Experienced traders can use futures contracts to bet on the future direction of an underlying asset or index. Simply put, it means that instead of buying or selling futures contracts, investors can wager on a group of assets by speculating on a bullish or bearish market. Traders must stay current with market developments in order to lock in successful positions when speculating.

Many traders utilize futures contracts to hedge against losses incurred as a result of excessive stock price swings. When stock prices fall, investors with a stock portfolio or equity index options sell futures contracts to reduce their risk of losing money. Futures contracts gain value in this case, as opposed to stock prices falling.

 

What are Index Futures? - FAQs

What is the meaning of margin in index futures trading?

You must deposit an initial margin with your broker before you can begin trading. This is a proportion of your total transaction value. It should also be sufficient to cover the most substantial conceivable loss in a single day, and it must be deposited by both buyers and sellers.

What is an index futures contract's maturity period?

On a rolling basis, these futures are available for maturities of one, two, and three months.

What is the method for settling index futures contracts?

The contract is settled in cash at the conclusion of the expiration period; no shares are delivered. The buyer would have gained a profit, and the seller would have lost if the index was higher than the strike price at the end of the expiry term. If the index falls below a certain level, the seller or future writer will lose money.

Who buys and sells index futures?

In the futures market, there are two categories of traders. 

  1. Those interested in hedging against share price fluctuations make up one part. These could be traded by a portfolio manager to protect against probable losses. If a portfolio's prices fall, he or she can sell these futures contracts at a higher price to offset the losses. Such hedging, on the other hand, will diminish overall profits.
  2. The speculator is another type of market participant. Futures are preferred by many speculators over single equities because risks are distributed across a broad range of stocks. In general, indices in growing economies will be trending upward.

Will index futures predict the stock market?

Stock futures are not a prediction as much as a bet. 

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