Derivatives Trading Basics
by 5paisa Research Team Last Updated: 2022-06-15T12:26:35+05:30

Introduction

The concept of index futures is a very common form of speculation. An index future is a contract to buy or sell a specific index for a specific price on a specific date. That might sound complicated, but it's a way to bet on the movement of a stock market index. Understanding this one can get you a long way in the stock market. 

For example, you could buy a futures contract for the S&P500. If the S&P loses value, you will be able to sell your contract at a profit. But if it gains value, you will lose money. This strategy is known as futures arbitrage, and professional traders use it to profit off even the smallest market movements.

How to Trade Index Futures?

Want to trade index futures? It can seem quite complicated, but it's pretty simple. You start by choosing the index you want to trade. For example, you want to trade the S&P 500 index. Find out the required price movement to make a profit on that index. Decide how much money you want to risk per trade (called the "lots" size). 

Most people trade with at least 100 lots. Decide how often you want to trade (called the "weekly frequency"). Some people trade every day, some trade only on Mondays, and some trade every week. Call your broker to make the trade.

What to Consider While Trading Index Futures?

The derivative market is one of the most established markets that allow the investor to trade on the future value of an underlying stock. Generally, index futures are options on broad-based stock indices, such as the Dow Jones or Standard & Poor's 500. 

An index futures contract is a standardized contract that allows traders to speculate on the direction of an index. Investors will trade index futures based on the direction of the underlying stock market. Index futures are available on the value of the index, which means the investor will not own a specific stock, but instead owns a contract that is based on an underlying index.

What Are the Advantages and Disadvantages of Stock Index Futures?

Pros

There are several advantages of stock index futures. The most obvious advantage would have to be the high liquidity of the process. Compared to traditional stock trades, futures trading is much quicker and more efficient.

As far as government agencies go, the regulatory system for futures trading is much more streamlined and straightforward. This can be considered an advantage because there is less time wasted and more time for creating wealth for the buyer and seller.

Cons

One of the primary disadvantages of stock market index futures is that they increase volatility and cause the underlying stocks to become more volatile as well. This is due to how the futures work.

Futures contracts require a buyer and seller to make a deal for a particular commodity for a certain price at a particular date in the future. This means that there are many more people buying and selling at the same time, as opposed to a traditional stock that only has one buyer and one seller.

Conclusion

The main difference between index futures and index options is that futures are obligations to buy or sell a pre-established amount of an underlying at a specific date in the future, while options are the right but not the obligation to buy or sell a pre-established amount of an underlying at a specific date in the future.

Index futures are a popular way to invest in a specific economic sector without buying shares of the actual companies that comprise that sector. For example, a company might want to invest in the health care sector but not want to buy shares in any of the companies that comprise that sector.

In this case, the company could buy index futures that track the health care index. For more information, please drop your questions in the comments section.

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