What Are Stock Index Futures?

Definition and Examples of Stock Index Futures

Stock index futures are contracts between investors that essentially bet on a stock index's price changes—based on index points—on settlement day (the day agreed upon in the contract).

• Alternate name: Equity index futures

For example, a Micro E-mini S&P 500 Futures (MES) contract is worth $5 per index point. Imagine that Joe sells one MES contract to Ann. On the contract date, the S&P 500 was trading at 4,100. On the settlement date, the S&P 500 traded at 4,101. The S&P 500 may have moved much more than one point in between the contract and settlement dates, but on the settlement date, Ann owes Joe $5.

How Stock Index Futures Work

Stock index futures are derivatives, so no actual stocks change hands. Instead, the buyer and seller enter a contract with each other, the terms of which are specific to the contract. Stocks are generally purchased in lots, which can become costly, but lots are not purchased in these contracts.

Instead, each investor pays a margin to a broker, which is the amount required to maintain the futures contracts. When the contract is entered, both parties agree to pay the difference of the index movement between the day the contract was entered and the settlement date.

Index futures based on the S&P 500, Nasdaq 100, Russell 2000, and Dow Jones Industrial Average are available in the U.S. The table below lists the specifications for each of the contracts.

The Chicago Mercantile Exchange Group also has international index futures, as well as index futures for specific sectors such as utilities, healthcare, and communication services.

What It Means for Individual Investors

You can take short or long positions on hundreds of stocks for much less money than it would cost for each stock individually, and in much less time. While index futures are leveraged in that you use a smaller amount of capital to control a larger amount, you're trading more efficiently because you're using less money to trade.

The risks involved in index futures are the same as with any futures trading—there is no way to know which direction the markets and indexes will turn when the contracts expire. You might not be able to close a position, and your stop and market orders might not execute if trading volume is low.

Pros and Cons of Stock Index Futures

Pros Explained

The chief advantages of futures come down to cost and speculation potential:

• Speculation possibilities: You can speculate on future stock prices and give them more leverage. You have access to 24/7 securities trading in highly regulated markets and don't need to own the stocks on the index that the futures contract covers.
• Costs to trade: When you're buying stock index futures contracts, you’re paying much less than the listed price for the stocks on the index tracked by the futures contract. For example, a $2,480 per-share investment for 100 shares of a fund that tracks the S&P 500 Index would cost $248,000. If you were to buy one S&P 500 futures contract (or 100 shares of the index), you'd pay quite a bit less.

Cons Explained

The disadvantages of trading in futures are all about high risk and the necessity of holding cash:

• Leverage risks: One downside of index futures investing is the high risk of buying and selling these contracts. It's easy to wind up highly leveraged and lose your entire investment when market conditions go against you.
• Cash and margins: There is one vital aspect to think about when you trade stock index futures. To take part in trades, you must keep cash in a margin account at a brokerage firm. If you don't maintain your margin account, your broker will call you to replenish it. This is known as a "margin call." If you don't have the money to keep your margin account full, you face a real danger of building up high debt levels quickly to finance the account. Many traders have lost their personal assets and gone very deep into debt in the past because of margin calls.

Are Stock Index Futures Worth It?

Index futures trading can still be costly when you account for fees and maintaining a margin account. Margins might be very high, depending on the broker you use. Stock index futures give you the ability to trade entire indexes worth of stocks for much less, so if you enjoy trading and have the risk tolerance to deal with the possibility of losses, it can be a successful way to invest,

If you're determined to invest in stock index futures, it's best to consult with an investment advisor or another experienced financial professional before making any deals. You’ll benefit from objective investment advice that may help steer you toward more measured and responsible investment decisions.