What are index futures
Stock index future
Stock Index Future; 1. term: contractual obligation to buy or sell an index value at a specified time at an agreed price. Since the index value is based on a fictitious basket of shares, physical delivery (physical fulfillment) of the underlying value on the due date is excluded. The contract is fulfilled through cash settlement. The index value is basically a leading market index. The DAX future traded on Eurex is based on the German stock index (DAX) and the US contracts with the highest turnover are based on the Major Market Index or the Standard & Poor's indices, which comprise 30 or 100/500 US standard values.
2. Possible uses:
a) Speculation / trading: Stock index futures give investors the opportunity to participate in the development of the stock market. Speculatively oriented investors can bet on rising prices by buying contracts and falling prices by selling them. If the future market development is correctly assessed, buyers and sellers of futures on stock indices have a theoretically unlimited profit potential, limited only by the expiry date of the contract, which is offset by an equally high potential for loss if the prices develop contrary to expectations. On the other hand, market participants can realize profits achieved at any time during the term of a position or limit accumulated losses by breaking out of their existing obligations by closing out (closing out transaction). Profits and losses result from the difference between the price at which the position was opened and the forward price applicable when the position was closed.
b) Hedging: In addition to speculative use, index futures can also be used as hedging instruments. By taking a position on the futures market that is opposite to the cash position, market participants try to compensate for impairments or loss of opportunity in connection with the cash position by making profits from the forward position. Diversified equity portfolios can, for example, be hedged against price losses by selling contracts (short futures position) (short hedge). The required number of contracts is calculated by dividing the amount to be hedged by the contract value (current index level times index multiplier). If there is a downward trend on the stock market after opening this short position, the loss in value of the portfolio is largely offset by the increase in the value of the contract position. Conversely, a market participant can hedge an equity investment planned for a later date by buying contracts (long futures position) against price increases in the meantime (long hedge). Higher cost prices are offset by the profit from the futures position. A complete neutralization of the price risks, a so-called perfect hedge, cannot be realized because, on the one hand, the prices on the spot and futures markets do not develop in the same direction (basis) and, on the other hand, the composition of the index and the portfolio to be hedged change distinguish. In order to ensure that the development of the value of the cash and futures position is as consistent as possible, the number of contracts to be bought or sold is often corrected using the beta factor that determines the price sensitivity of a share or portfolio to a given one Index measures.
c) arbitrage: A third way of using stock index futures is to take advantage of price differences between the cash and futures markets (arbitrage). The overrated title is sold and the underrated one is bought. After the price imbalance has been settled, the positions are closed again.
See also financial futures contracts.
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