What Are Index Futures? How Do They Work?

Stock Index Futures in India: An Overview

A stock market index consists of a certain group of stocks. It helps investors to compare and gauge the stock market performance. Stocks can be added to a certain index when they fulfill certain criteria such as market capitalization, positive price movement, healthy financials, consistent increase in earnings, and good liquidity. In this article, we are going to learn about what are index futures, future indexes, index futures investing, and benefits of index futures trading. 

What Are Index Futures?

The index future is a contract that allows you to buy or sell derivatives at a future date at a fixed price. The contract has to be settled within the expiry date. You can trade in various financial instruments such as stocks, currencies, or commodities and can buy certain quantities as per your choice at a future date. All you have to do is speculate on the price of the index such as NIFTY 50 or S&P 500 at a future date using index futures. Stock index futures are used by traders as well as investors and fund managers to minimize losses. 

In the year 2000, India's first index-based stock futures contracts were introduced and are traded on both NSE (National Stock Exchange) and BSE (Bombay Stock Exchange). NSE and BSE are the two leading exchanges in India. There are various indices available to trade such as Bank Nifty, NIFTY 50, NIFTY 100, and BSE Sensex. 

Key Takeaways

• Index futures enables a trader to trade in derivatives at a fixed price at a future date. 
• Traders who have considerable years of experience trading in the stock market should prefer to trade in futures contracts. 

How Do Index Futures Work?

An index value is determined by the price movements of stocks that are listed on the index. It helps you to gauge the performance of a certain index. With the help of future indices investing, one can trade in various indices. The fluctuations in the stock price let the traders make a profit from index futures trading. 

Traders can either buy or sell the derivatives (stocks, currencies, or commodities) at a fixed price at a future date by predicting the market sentiment and future price movement of the security.  For example, if you think that the price will go down, you should place a sell order. On the other hand, if you predict that the price will go up, then you should place a buy order. You need to keep in mind that these contracts have an expiry date and within this date, you must close your position. 

Types of Stock Index Futures

Nifty 50: Nifty 50 index consists of the top 50 companies. 

Nifty Bank: Nifty Bank consists of shares of banking companies. Hence, Nifty Bank Futures will be determined by the performance of the banking companies. 

Nifty IT: Nifty IT consists of companies that deal in information technology. The nifty It futures will depend on how the IT companies are performing.

S&P BSE Sensex: S&P Sensex consists of the top 30 companies. 

S&P BSE Bankex: S&P BSE Bankex index consists of banking stocks that are listed on BSE. 

S&P BSE Sensex 50: S&P BSE Sensex 50 index consists of 50 stocks that have the largest market capitalization. 

S&P BSE Bharat 22 Index: The index consists of 22 companies that are disinvested by the central government of India. 

Advantages of Stock Index Futures

• Trading in nifty futures allows you to invest in whole sector stocks. The best part is that you have the option to roll over your position every month or as long as you want. Hence, it allows you to avoid stock risk. 
• Index futures contracts give you the option to trade on the long side as well as the short side. 
• The STT and commission rates on index futures are comparatively lower than equities or stock futures. Hence, trading in index futures is economical. 
• Traders can add sectoral index futures to their portfolios for diversification. Diversifying your portfolio reduces the risk because the risk is not limited to a single stock. 
• Traders can take large positions by taking leverage. However, traders might face a huge loss if the trade doesn't move the way they predicted. 
• Traders have to pay a small fraction of the transaction to trade in big amounts with the help of margin funding from brokers. 

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Conclusion

Index futures trading can give you lucrative profits if you use the right strategy and risk management. You do not need to have a large amount of capital to trade in stock index futures contracts because most brokers give leverage. However, you need to keep in mind that taking high leverage can be risky and you may end up losing all your money. So make sure to analyze your trading objective and risk tolerance before doing future indices investing. 

This is not an investment advisory. The blog is for information purposes only. Investments in the securities market are subject to market risks, read all the related documents carefully before investing. Past performance is not indicative of future returns. Please consider your specific investment requirements, risk tolerance, goal, time frame, risk and reward balance, and the cost associated with the investment before choosing a fund, or designing a portfolio that suits your needs. The performance and returns of any investment portfolio can neither be predicted nor guaranteed.