Business

When and why it's worth taking a look at stock index futures

It's been a few volatile weeks on Wall Street. For this reason, a special type of financial security known as stock index futures has received more attention than usual. But what are index futures and what can they tell you about the economy?

Let's start with the basics

Futures are a type of financial guarantee in which two parties agree to buy or sell an asset on a predetermined date at a predetermined price. Businesses and investors can use them to reduce their exposure to adverse changes in the value of an asset.

Time for an example

Suppose you have a grocery owner who wants to sell apples in his store next October when apples are in season, said Michelle Lowry, professor of finance at TD Bank at Drexel University. So the grocer is sitting there saying, well, I know I'm going to have to buy apples in October, but I don't know what the price will be. It’s very uncertain. And I don't like uncertainty.

The grocer could wait until October to buy apples or enter into a futures contract. The grocer would agree now to pay a price they agreed to for a bushel of apples in October, said Lowry.

The grocer doesn't really want buy apples now, but by signing a futures contract, they were locking in the price they will pay for apples in October, protecting themselves from huge increases in apple prices.

OK, what about stock index futures?

Stock index futures work the same way, but instead of agreeing to sell apples at a predetermined price and date, two parties agree to buy stocks from a stock index like the S&P 500 or the Dow Jones Industrial Average at a predetermined price and date.

Just as the grocer in our example above could use futures to hedge against unfavorable changes in apple prices, investors can use stock futures to protect themselves from adverse market swings. fellow.

What can you learn by watching them?

Every morning I wake up before the market opens and watch how the markets react before the market opens, said Adam Grealish, chief investment officer at an online investment company called Betterment .

Stock index futures are traded on exchanges whose hours of operation are different from those of the New York Stock Exchange and NASDAQ. For this reason, traders can use the futures market to adjust their positions overnight and late on Sunday.

This is why futures prices somehow, overall, represent for everyone the average expectations of people as to what the market will do, said Lowry. In other words, if you look at the futures market, you know, you get up in the morning, make your cup of coffee, you turn on the television and it says that the futures contracts are down 2%. This is a pretty good indication that the market will open at around 2%.

Stock index futures are not a crystal ball

While taking a look at the stock index futures on Sunday and weekday evenings or before trading starts in the morning can give some insight into how traders digest news, Lowry warned against view the index futures market as a crystal ball for individual investors.

If the futures are down 2%, that doesn't mean you should sell your shares, and if its 2% rise doesn't mean you should buy more stocks, said Lowry. It is an indication of the opening of the market, it is not an indication of a profitable business strategy.

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