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Index Futures Trading – Is It Just Me Or Am I Seeing Double?

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Introduction

 

 

So there is a lot of questions that are going around, wanting us to comment on the differences between index ETFs and index futures – they both seem to be the same types of asset after all right?

Well it’s not that simple, as there are a few differences between them and in today’s lesson, we will be covering index futures trading to its entirety – and expose the difference between these “copy cat” assets.

 

But before we begin, we would like you to read and agree to the Terms & Conditions of this post before you proceed any further.

Disclaimer: Invest In Wall Street is in no way financially or legally responsible for any investing decisions made by any of our readers and are, in turn, acting on their own free will. The information in this article is purely educational and should not be abused or misconstrued in any way, shape, or form.

 

Index Futures: Imitation Is The Sincerest Form Of Flattery

 

In the futures market, index futures contracts are among the most widely traded.

They’re popular among some traders because they track stock indices, such as the S&P 500.

You might be thinking that exchange-traded funds, or ETFs, track the same indices.

So what’s the difference?

One key difference between index futures and ETFs is that futures involve a lot of leverage. This means, with the futures contract, you’re able to leverage a large amount of money with a small investment.

For this reason, traders typically use index futures for active trading or hedging.

With this high degree of leverage comes a higher level of risk – that’s why some traders consider index futures to be an alternative investment.

 

 

As a result, these traders typically devote a smaller portion of their portfolios to index futures.

Let’s examine some common index futures contracts and their characteristics.

To do so, we’ll look at these four contracts – the E-mini S&P 500, the mini Dow Jones Industrial Average, the E-mini NASDAQ 100, and the E-mini Russell 2000.

Characteristics Of Index Funds: Monkey See, Monkey Do

 

 

Each offers slightly different levels of leverage.

To better understand just how much leverage these contracts offer, let’s calculate each contract’s dollar value based on hypothetical index values.

To do this, you need to examine the multiplier for each index futures contract.

It works like this. The multiplier for the E-mini S&P 500 is $50. So you multiply the level of the index by $50 – and this gives you the contract’s dollar value.

For example, if the S&P 500 index is trading at 2,500, the total value controlled by one futures contract is would be $125,000.

Each index futures contract has a different multiplier. To find the value of any contract, simply multiply the current index level by the index futures multiplier.

 

 

Now that you know how to calculate the value of an index futures contract, lets figure out how much leverage each offers.

To do this, you’ll compare the value of each contract against its initial margin.

The initial margin is the amount of money a trader needs to control one contract to enter a futures trade. Initial
margins are determined by the exchanges and frequently change, so check with your current broker to get current margins.

With the dollar value and the initial margin, you can better understand the leverage associated with each contract.

The ratio of the contract’s value and the initial margin defines the degree of leverage.

Clearly, there is a large degree of leverage involved with each futures contract.

For example, the E-mini S&P 500 contract offers 27 times leverage.

 

 

Traders should consider the different levels of leverage when deciding which contract to trade.

Leverage is just one characteristic of index futures. Another characteristic is that index futures trade nearly 24 hours per day, six days per week.

After the stock markets closes, index futures continue trading throughout the night.

Because the markets are open almost around the clock, traders watch index futures to attempt to gauge changes that may happen outside equity market hours and in international markets.

Some traders trade index futures in the overnight market as a way to hedge a portfolio of stocks.

 

Risks Of Index Futures: Hey, Stop Copying Me!

 

 

Another reason traders trade index futures is because the markets are typically very liquid – however, its important to know that the high degree of leverage cuts both ways.

Leverage is also one of the biggest risks of index futures. So keep in mind that although leverage allows for strong potential returns, it can also result in significant losses.

Another risk concerns the electronic nature of these markets. There’s a lot of computer-driven trading in index futures, which means prices can move very fast.

News events, such as economic reports and central bank announcements, can result in large and fast moves, which can lead to big losses.

 

 

To attempt to protect against these fast market conditions, many futures traders use stop and limit orders to help manage risk.

Traders using index futures understand the benefits and risks that come with such high degrees of leverage, that why some may dedicate only a small percentage of their overall portfolio to this investment.

Others can simply use these futures as a helpful tool and watch their performance in the overnight markets to see what tomorrow might bring in the stock market.

There is a lot of risk in futures trading, which is why its important to educate yourself before you start trading.

 

Related image

 

Quick Recap

Index Futures

 

  • In the futures market, index futures contracts are among the most widely traded
  • One key difference between index futures and ETFs is that futures involve a lot of leverage. This means, with the futures contract, you’re able to leverage a large amount of money with a small investment
  • For this reason, traders typically use index futures for active trading or hedging
  • With this high degree of leverage comes a higher level of risk – that’s why some traders consider index futures to be an alternative investment
  • As a result, these traders typically devote a smaller portion of their portfolios to index futures

 

Characteristics Of Index Futures

 

  • Each offers slightly different levels of leverage
  • To better understand just how much leverage these contracts offer, let’s calculate each contract’s dollar value based on hypothetical index values
  • To do this, you need to examine the multiplier for each index futures contract
  • Each index futures contract has a different multiplier. To find the value of any contract, simply multiply the current index level by the index futures multiplier
  • Now that you know how to calculate the value of an index futures contract, lets figure out how much leverage each offers.
    To do this, you’ll compare the value of each contract against its initial margin
  • The initial margin is the amount of money a trader needs to control one contract to enter a futures trade. Initial margins are determined by the exchanges and frequently change, so check with your current broker to get current margins
  • With the dollar value and the initial margin, you can better understand the leverage associated with each contract
  • The ratio of the contract’s value and the initial margin defines the degree of leverage
  • Leverage is just one characteristic of index futures. Another characteristic is that index futures trade nearly 24 hours per day, six days per week
  • After the stock markets closes, index futures continue trading throughout the night
  • Because the markets are open almost around the clock, traders watch index futures to attempt to gauge changes that may happen outside equity market hours and in international markets
  • Some traders trade index futures in the overnight market as a way to hedge a portfolio of stocks

 

Risks Of Index Futures

 

  • Another reason traders trade index futures is because the markets are typically very liquid – however, its important to know that the high degree of leverage cuts both ways
  • Leverage is also one of the biggest risks of index futures. So keep in mind that although leverage allows for strong potential returns, it can also result in significant losses
  • Another risks concerns the electronic nature of these markets. There’s a lot of computer-driven trading in index futures, which means prices can move very fast
  • News events, such as economic reports and central bank announcements, can result in large and fast moves, which can lead to big losses

 

Protecting Yourself Against Market Risk

 

  • To attempt to protect against these fast market conditions, many futures traders use stop and limit orders to help manage risk
  • Traders using index futures understand the benefits and risks that come with such high degrees of leverage, that why some may dedicate only a small percentage of their overall portfolio to this investment
  • Others can simply use these futures as a helpful tool and watch their performance in the overnight markets to see what tomorrow might bring in the stock market

 

 

 

 

And this in short is index futures – and as the name implies, these futures often mimic the behavioral patterns of common stock indices.

These assets are slightly different from that of your typical index ETF because, index futures often require less capital and give the trader a greater amount of leverage.

They are also commonly known for the amount of leverage which can be attractive to investors and traders looking to capitalize on their ROI – are extremely liquid and in some cases volatile – which can go one of either two ways.

So an index ETF is more of something that you want to INVEST in or “hold” while an index future is an asset that you would most likely “TRADE” – perhaps on a daily, weekly, monthly, or yearly basis – all based on your personal preference.

Note that this is typically not an asset that some may have in their portfolio – which is perfectly fine, but their are some traders and investors who chose to incorporate futures such as this in their portfolio as a way to boost their overall portfolio, as this can payout handsomely if used correctly.

Another perk of index futures is that they can be traded almost around the clock – 24/7, 6 days a week. This accessibility is only exclusive to this particular asset class – among some other derivatives, allowing traders to watch any notable price movement in the overnight market, hedge their bets, or even adapt a new strategy for the day(s) ahead.

It should be noted that trading index futures – or any form of stock market derivatives requires an extensive amount of experience and expertise that takes years to master – as this type of trading is not recommended should only be implemented by the more advanced and sophisticated traders and investors.

I hope you have enjoyed this post and found the information to be quite useful. If you have any questions or concerns, please feel free to leave them down in the comment thread below and make sure to like and share this post.

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