An index futures contract binds the parties to an agreed value for the underlying index at a specified future date. One party is long and the other short - and the loser must pay the winner the difference between the agreed index futures price and the index closing value at expiration. Fair Value of an Index Future Although index futures are closely correlated to the underlying index, they are not identical. An investor in index futures does not receive if long or owe if short dividends on the stocks in the index, unlike an investor who buys or sells short the component stocks or an exchange-traded fund that tracks the index.

Index futures trade on margintoo: The index futures price must equal the underlying index value only at expiration. At any other time, the futures contract has a fair value relative to the index, which reflects the expected dividends forgone a deduction from the index value and the financing cost for the difference between the initial margin and the principal amount of the contract an addition between the trade date and expiration.

When interest rates are low, the dividend adjustment outweighs the financing cost, so fair value for index futures is typically lower than the index value. Market participants use index futures for many different purposes, including hedging ; adjusting asset allocation through index futures overlay programs or transition management; or outright speculation on market direction.

Whenever the index futures price moves away from fair value, it creates a trading opportunity called index arbitrage. As soon as the index futures price premium, or discount to fair value, covers their transaction costs clearing, settlement, commissions and expected market impact plus a small profit margin, the computers jump in, either selling index futures and buying the underlying stocks if futures trade at a premiumor the reverse if futures trade at a discount.

Index Futures Trading Hours Index arbitrage keeps the index futures price close to fair value, but only when both index futures and the underlying stocks are trading at the same time.

While the stock market opens at 9: Liquidity in index futures drops outside stock exchange trading hours because the index arbitrage players can no longer ply their trade. If the futures price gets out of whack, they cannot hedge an index futures purchase or sale through an offsetting sale or purchase of the underlying stocks.

But other market participants are still active. Index Futures Predict the Opening Direction Suppose good news comes out abroad overnight - the ECB cuts interest rates, or China reports stronger than expected growth in GDP. The local equity markets will probably rise, and investors may anticipate a stronger U. If they buy index futures, the price will go up.

And with index arbitrageurs on the sidelines until the U. As soon as New York opens, though, the index arbitrageurs will execute whatever trades are needed to bring the index futures price back in line - price movements in a stock index futures market this example, by buying the component stocks and selling index futures. Investors cannot just check whether the futures price is above or below its closing value on the previous day, though.

The dividend adjustments to index futures fair value change overnight they are constant during each dayand the indicated market direction depends on the price of index futures relative to fair value regardless of the preceding close.

Using Index Futures To Predict The Future | Investopedia

Ex-dividend dates are not evenly spread over the calendar, either; price movements in a stock index futures market tend to cluster around certain dates. On a day when several big index constituents go ex-dividend, index futures may trade above the prior close but still imply a lower opening.

Trading is typically volatile at the opening, which accounts for a disproportionate amount of total trading volume. If an institutional investor weighs in with a large buy cba stock market sell program in multiple stocks, the market impact can overwhelm whatever price movement the index futures indicate. Institutional traders do watch futures prices, of course, but the bigger the orders they have to execute, the less important the index futures direction signal becomes.

Late openings can also disrupt index arbitrage activity.

Index Futures

Although the forex expert advisor ezfx 2010 free download opens at 9: The opening price is set through an auction procedure, and if the bids and offers do not overlap, the stock remains closed until matching orders come in. The longer index arbitrageurs stay on the sidelines, the greater the chances that other market activity forex 50 retracement negate the index futures direction signal.

The Bottom Line If the futures price suggests the market will rise on the opening, investors who wish to sell that day may want to wait until after daily turnover of forex market market opens before entering their order, or set a higher price limit.

Buyers may want to hold off live currency converter api index futures predict a lower opening, too. Nothing is guaranteed, however; index futures do predict the opening market direction most of the time, but even the best soothsayers are not always right.

Investors can monitor futures prices and fair values on websites like CNBC or CNN Moneyboth of which also show pre-market indications for individual stocks a less reliable indicator due to poor liquidity.

Dictionary Term Of The Day. A measure of what it costs an investment company to operate a mutual fund. Latest Videos PeerStreet Offers New Way to Bet on Housing New to Buying Bitcoin?

This Mistake Could Cost You Guides Stock Basics Economics Basics Options Basics Exam Prep Series 7 Exam CFA Level 1 Series 65 Exam. Sophisticated content for financial advisors around investment strategies, industry trends, and advisor education. Using Index Futures To Predict The Future By Neil O'Hara Share. Index options, financial derivatives that derive their value from a stock index, can provide stability and peace of mind for less risky investors.

An index is a statistical means of calculating a change in an economy or market. Learn about the advantages and disadvantages of stock indexes and passive index funds. Discover how there is an opportunity cost to using index funds.

Futures contract - Wikipedia

Index funds, at their best, offer a low-cost way for investors to track popular stock and bond market indexes. But not all index funds are created equally. Tracking errors tend to be small, but they can still adversely affect your returns. Learn how to protect against them. Here's help in making the decision. A capitalization-weighted index is a market index whose individual components are weighted according to their market capitalization.

Any derivative that exists can be securitized into a future, though of course most investors deal with the stock variety. Here's how they're priced. Learn how the fair value for futures stock index contracts is calculated, and understand how differences between those numbers Every morning before North American stock exchanges begin trading, TV programs and websites providing financial information First, let's review the definition of an index.

An index is essentially an imaginary portfolio of securities representing There are a few ways to find out what indexes a company is involved in, and investors should take note of them when they Learn about stock index options, including differences between single stock options and index options, and understand different An expense ratio is determined through an annual A hybrid of debt and equity financing that is typically used to finance the expansion of existing companies.

A period of time in which all factors of production and costs are variable. In the long run, firms are able to adjust all A legal agreement created by the courts between two parties who did not have a previous obligation to each other.

A macroeconomic theory to explain the cause-and-effect relationship between rising wages and rising prices, or inflation. A statistical technique used to measure and quantify the level of financial risk within a firm or investment portfolio over No thanks, I prefer not making money.

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