The Benefits of Index Futures Trading

Let's be fair, index futures trading is an enigma to most of us: you agree a price today for something you're not actually going to take delivery of until tomorrow. In the meantime, the value of what you've agreed to buy could go up, i.e. increase in value; go down, i.e. decrease in value; or stay the same - all of which are largely dependent on circumstances outside of your control! 

However, even more mysterious to us is index futures trading - after all, if you're that interested in the index's stock: why not just go and buy it? 

To answer this, the following is a brief explanation of some of its benefits.

Index futures trading - brief explanation

Taking a position (which basically means participating) in index futures can be done either as what is known as a "long position" or "short position".  A long position is a contract where you agree to lock-in the price of an underlying cash index stock portfolio on the expiration of that futures contract. A short position is where you fix the selling price of the index portfolio. In both cases the contract will specify the month and year in which delivery of the settlement must occur - and delivery can be either physical delivery or cash settlement, depending on the terms of the contract.

Index futures trading - the benefits

Index trading is a substitute for holding a diverse stock portfolio in any given index, such as NASDAQ, and is a means of gaining broad exposure without the need to purchase a whole set of stock in that index. Consequently, the benefits are:

• protection from losses that arise from changes in individual stock prices;

• the opportunity to mimic an index without needing to exposure yourself to the risk of actually holding individual stock in the index;

• an immediate chance to exploit changes in an index - which is seen as being especially beneficial in volatile developing markets

• lower operating costs - as you should be paying lower commissions than of you expose yourself to a cross-section of individual stock; and

• lower initial capital outlay, as you can take a position in an index without needing to settle immediately (although you may be asked to hedge your position losses/profits in a margin account).

One note of caution: if you agree to take a position over a prolonged period, you could easily lose your shirt if you have no knowledge or understanding of the index you are dealing in - so make sure your do sufficient research!

Not withstanding this, the benefits of index trading provide you with the chance to participate in the market with less of a risk than in you expose yourself to positions in numerous individual stocks.