index futures are agreements whose value is derived from a financial index essentially they are agreements to trade the value of an index at a future time reflecting expectations of the index s future direction in price originally intended for institutional investors index futures are open to individual investors traders can use these contracts to speculate on the price direction indexes such as the s p 500 and the dow jones industrial average djia popular futures include fractional index futures that trade at lower prices than those aimed at institutional investors like the chicago mercantile exchange s cme e mini s p 500 investors also use index futures to hedge their equity positions against potential losses 
understanding index futuresan index tracks the price of an asset or a group of assets such as equities commodities and currencies a futures contract is a derivative that obligates traders to buy or sell the underlying asset on a set day at a predetermined price putting these together an index future is a legal contract that obligates traders to buy or sell a contract derived from a stock market index by a specific date at a predetermined price index futures which are also called stock or equity market index futures work just like other futures contracts they give investors the power and obligation to deliver the contract s cash value based on an underlying index on a specified date at an agreed upon price unless the contract is unwound before expiration through an offsetting trade the trader is obligated to deliver the cash value on expiry this differs from other types of futures like those involving commodities where a party might be obligated to hand over the underlying asset at expiry not cash traders use index futures to hedge or speculate against future price changes in the underlying equity index for example the s p 500 tracks the stock prices of 500 of the largest companies traded in the u s an investor could trade index futures on the s p 500 to hedge or speculate on gains or losses of the index index futures do not predict future index performance types of index futuresthe most popular index futures are based on equities which means investors hedge their bets on the individual index named in the contract 1for instance traders can invest in the s p 500 index by purchasing e mini s p 500 futures contracts investors can also trade futures for the dow jones industrial average and nasdaq 100 index as well as their more accessible versions the e mini dow and e mini nasdaq 100 futures and their even smaller variants the micro e mini dow and micro e mini nasdaq 100 2outside the u s there are futures available for the dax stock index which comprises 30 major german companies and the swiss market index both of these futures trade on the eurex in hong kong hang seng index futures allow traders to speculate on that market s major index index futures may use different multiples to determine the contract price for example the e mini s p 500 futures contract which trades on the cme has a value of 50 times the value of the index so if the index trades at 3 400 points the market value of the contract would be 3 400 x 50 or 170 000 3aside from the more conventional futures contracts that derive their value from the fluctuations in prices of financial instruments there are index event futures which depend on expectations for a specific index events covered by these kinds of futures can range from electoral results illegal except for research purposes in the u s to shifts in equities and commodity prices as well as specific indexes an event futures contract has a binary outcome it culminates at a predetermined value and resolves at zero if the anticipated event fails to occur the cme began offering events futures in 2022 with daily expiries expanding them to include quarterly and annual expirations in 2024 a typical index future might be will e mini s p 500 daily close above a given point value like 5 000 points you would get a certain return if you bet on yes and another return based on no if it turns out you were correct and depending on how others in the market are feeling about that outcome 4in 2022 the chicago mercantile exchange began offering index event futures which require you to choose yes or no to whether an index will go above a certain level paying out if you re right and leaving you with nothing if you re wrong 4index futures and marginsfutures contracts don t require the buyer to put up the entire value of the contract when entering a trade instead buyers must keep just a fraction of the contract amount in their account this is called the initial margin 5index futures prices can fluctuate significantly until the contract expires as such traders must have enough money in their accounts to cover a potential loss which is called the maintenance margin this sets the minimum amount of funds an account must hold to satisfy future claims the financial industry regulatory authority requires a minimum of 25 of the total trade value as the minimum account balance although some brokerages ask for more 6 as the value of the trade climbs before expiration the broker can require that more funds be added to the account this is called a margin call 7it s important to note that index futures contracts are legally binding agreements between the buyer and seller futures differ from options since futures come with an obligation an option meanwhile is a right the holder may or may not exercise profits and losses from index futuresan index futures contract states the holder agrees to purchase an index at a particular price on a specified date index futures typically settle quarterly in march june september and december there are usually several annual contracts as well 5equity index futures are cash settled this means there will be no delivery of the underlying asset at the end of the contract if the index price is higher than the agreed upon contract price at the expiry date the buyer makes a profit while the seller known as the future s writer suffers a loss in the reverse scenario the buyer suffers a loss while the seller makes a profit for example if the djia closes at 16 000 at the end of september the holder with a september futures contract one year earlier at 15 760 reaps a profit the difference between the entry and exit prices of the contract determines profits as with any speculative trade there are risks the market could move against the position the trading account must meet margin requirements and could receive a margin call to cover any risk of further losses the trader must understand that many factors can drive market index prices including macroeconomic conditions such as economic growth and corporate earnings index futures for hedgingportfolio managers often buy equity index futures as a hedge against potential losses if the manager has positions in many stocks index futures can help hedge the risk of declining stock prices by selling equity index futures 8since many stocks tend to move in the same general direction the portfolio manager could sell or short an index futures contract if stock prices decline if there s a market downturn the stocks within the portfolio would fall in value but the sold index futures contracts would gain offsetting the losses from the stocks the fund manager could hedge all the downside risks of the portfolio or only partially offset them the downside of hedging is that this reduces profits if the hedge isn t required so if an investor with a september futures contract shorts index futures and the market rises the index futures would fall in value the losses from the hedge would offset gains in the portfolio as the stock market rises index futures for speculatingspeculation is a sophisticated trading strategy not suited for many investors experienced traders tend to use index futures to speculate on the direction of an index instead of buying individual stocks or assets a trader can bet on the direction of a group of assets by buying or selling index futures for example to replicate the s p 500 index investors would need to buy all 500 stocks in the index instead index futures can be used to bet on the direction of all 500 stocks with one contract creating the same effect of owning and properly weighing the 500 stocks in the s p 500 pros and cons of using index futuresindex futures can hedge against declines in similar holdingsbrokerage accounts require only a fraction of the contract s value held as a marginindex futures allow for speculation on changes in the index s valuehelps businesses prepare for potential changes in the wider market that would affect their bottom lineunnecessary or wrongly directed hedges will curtail portfolio gainsbrokers may demand additional funds to maintain the account s margin amountindex futures speculation is high riskunforeseen events may cause the index to move in the opposite directionindex futures vs commodities futures contractsby their nature stock index futures work differently from commodity futures the latter allow traders to buy or sell a specified amount of a commodity at an agreed upon price on an agreed upon date in the future contracts are usually exchanged for tangible goods such as cotton soybeans sugar crude oil gold etc investors generally trade commodity futures to hedge or speculate on the price of the underlying commodity unlike index futures which are cash settled long position holders of commodity futures contracts will need to take physical delivery if the position has not been closed out ahead of expiry 8businesses frequently use commodity futures to lock in prices for the raw materials they need for production examples of index futureslet s say you decide to speculate on the s p 500 the e mini s p 500 futures are priced at 50 multiplied by the index value so you might buy a futures contract when it s trading at 5 000 points resulting in a contract value of 250 000 50 x 5 000 because index futures don t require investors to put up the full 100 you need only to maintain a small percentage in your brokerage account 