Explain index future contractn



Future contract is the contract that allows the buyer/seller to buy/sell a particular commodity at a strike price at a future date. Stock futures enable investors to buy a certain quantity of stocks at strike price on a future date. Stock futures contracts were introduced in 2000 which were index based.

Traders in future index are divided into two types as follows−

  • People interested in hedging against share price movements
  • Speculator

Index future types

  • S&P BSE Sensex (in this, 30 underlying securities makes BSE sensitive Sensex)
  • Nifty 50 (in this, 50 underlying securities makes NSEs nifty index)
  • Nifty IT (in this, information technology shares makes up underlying securities)
  • Nifty bank (bank shares)
  • S&P BSE bankex (bank stock listed on Sensex)
  • S&P BSE Sensex 50 (in this Sensex there will be 50 stocks)
  • S&P BSE bharat 22 Index (stocks of 22 central public sector enterprises)

Index future contract

In this contract, traders can buy or sell a financial index today at a set price and final settlement on a future date. Portfolio managers use these contracts to hedge their position (equity) against loss. It tells about market direction. Some of the popular future indexes are E-mini S&P 500, Nasdaq-100, Dow etc.

Settling the contracts

  • Before expiry

Based on the market rate or investor’s decision, contracts can be settled before expiry in future markets. Sometimes investors don’t want to wait till expiry date to exit his position. For some investor’s time, their sale is based on perception of market movement and investment horizon.

  • On expiry

These settled in cash and closing value on expiry date is considered as settling price for future index.

Advantages

  • Portfolio managers use this to hedge against price decline.
  • Less brokerage (only a fraction of value held).
  • Allows speculations.
  • Companies used to lock Commodity prices.

Disadvantages

  • Can damage a portfolio by unnecessary hedges.
  • Some brokers ask for additional money to maintain.
  • High risk.
  • Unforeseen factors may affect the index.

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