In
finance, a stock market index future is a cash-settled
futures contract
In finance, a futures contract (sometimes called a futures) is a standardized legal contract to buy or sell something at a predetermined price for delivery at a specified time in the future, between parties not yet known to each other. The asset ...
on the value of a particular
stock market index. The turnover for the global market in exchange-traded equity index futures is notionally valued, for 2008, by the
Bank for International Settlements
The Bank for International Settlements (BIS) is an international financial institution owned by central banks that "fosters international monetary and financial cooperation and serves as a bank for central banks".
The BIS carries out its work thr ...
at US$130 trillion.
Uses
Stock index futures are used for
hedging,
trading
Trade involves the transfer of goods and services from one person or entity to another, often in exchange for money. Economists refer to a system or network that allows trade as a market.
An early form of trade, barter, saw the direct excha ...
, and
investments
Investment is the dedication of money to purchase of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort.
In finance, the purpose of investing is ...
. Index futures are also used as leading indicators to determine market sentiment.
Hedging using stock index futures could involve hedging against a portfolio of shares or equity index options.
Trading using stock index futures could involve, for instance, volatility trading (The greater the volatility, the greater the likelihood of
profit taking – usually taking relatively small but regular profits).
Investing via the use of stock index futures could involve exposure to a market or sector without having to actually purchase shares directly.
There are cases of equity hedging with index futures.
One case is where a portfolio 'exactly' reflects the index (this is unlikely) so that the portfolio is perfectly hedged via the index future.
Another case is where a portfolio does not entirely reflect the index (this is more likely to be the case). Here, the degree of correlation between the underlying asset and the hedge is not high. So, your portfolio is unlikely to be 'fully hedged'.
Equity index futures and
index options tend to be in liquid markets for close to delivery contracts. They trade for cash delivery, usually based on a multiple of the underlying index on which they are defined (for example £10 per index point).
OTC products are usually for longer maturities, and are usually a form of options product. For example, the right but not the obligation to cash delivery based on the difference between the designated strike price, and the value of the designated index at the ''expiration date''. These are traded in the wholesale market, but are often used as the basis of guaranteed equity products, which offer retail buyers a participation if the equity index rises over time, but which provides guaranteed
return of capital
Return of capital (ROC) refers to principal payments back to "capital owners" (shareholders, partners, unitholders) that exceed the growth (net income/taxable income) of a business or investment. It should not be confused with Rate of Return (ROR ...
if the index falls. Sometimes these products can take the form of
exotic option
In finance, an exotic option is an option which has features making it more complex than commonly traded vanilla options. Like the more general exotic derivatives they may have several triggers relating to determination of payoff. An exotic op ...
s (for example
Asian options An Asian option (or ''average value'' option) is a special type of option contract. For Asian options the payoff is determined by the average underlying price over some pre-set period of time. This is different from the case of the usual European o ...
or
Quanto options In finance, the style or family of an option is the class into which the option falls, usually defined by the dates on which the option may be exercised. The vast majority of options are either European or American (style) options. These optionsâ ...
).
Pricing
Forward prices of equity indices are calculated by computing the
cost of carry
The cost of carry or carrying charge is the cost of holding a security or a physical commodity over a period of time. The carrying charge includes insurance, storage and interest on the invested funds as well as other incidental costs. In intere ...
of holding a long position in the constituent parts of the index. This will typically be
the
risk-free interest rate
The risk-free rate of return, usually shortened to the risk-free rate, is the rate of return of a hypothetical investment with scheduled payments over a fixed period of time that is assumed to meet all payment obligations.
Since the risk-free ra ...
, since the cost of investing in the equity market is the loss of interest
minus the estimated
dividend yield
The dividend yield or dividend–price ratio of a share is the dividend per share, divided by the price per share. It is also a company's total annual dividend payments divided by its market capitalization, assuming the number of shares is constant ...
on the index, since an equity investor receives the sum of the dividends on the component stocks. Since these dividends are paid at different times, and are difficult to predict, estimation of the forward price can be difficult, particularly if there are not many stocks in the chosen index.
Indices for futures are the well-established ones, such as
S&P 500
The Standard and Poor's 500, or simply the S&P 500, is a stock market index tracking the stock performance of 500 large companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices. As of ...
,
FTSE,
DAX
Dax or DAX may refer to:
Business and organizations
* DAX, stock market index of the top 40 German companies
** DAX 100, an expanded index of 100 stocks, superseded by the HDAX
** TecDAX, stock index of the top 30 German technology firms
* Dax ...
,
CAC 40 and other
G12 country indices. Indices for
OTC products are broadly similar, but offer more flexibility.
See also
*
Derivative (finance)
*
SPI 200 futures contract
*
Notes
{{Authority control
Derivatives (finance)