In index futures, a trader can buy or sell a financial index today and have the transaction settled at a later date. Index futures are used by traders to speculate on the price direction of an index, such as the Nifty50. Additionally, investors and investment managers use index futures to protect their stock investments. In this post, you can understand index future, its types, how it works and its importance.
How Do Index Futures Work?
Futures contracts, including index futures, give traders and investors the power and responsibility to deliver the contract’s cash value based on the underlying index at a future date. A trader must provide the cash value on expiry unless the contract is cancelled or closed before expiration by an offsetting deal.
Futures based on indexes are derivatives, which means they are based on an underlying asset (the index). Traders use these products to trade a wide range of assets, including stocks, commodities, and currencies. Investors can trade with an expectation of the Nifty50 appreciation or depreciation by buying or selling index futures.
How to Trade Index Futures?
Index futures trading involves a lock-in of purchase and sell bids between a buyer and a seller. On a specific date and at a specific price, both parties agree to close their holdings lawfully. On behalf of traders, futures brokers place buy and sell orders. The next step is to create long and short positions with initial and maintenance margins for buy and sell orders.
The payment of futures contracts is entirely cash-based. A difference in the contract price can also be paid and received in cash by the seller and buyer on the expiration date. The buyer makes a profit when the price is higher, while the seller loses money when the price is lower.
Types of Index Futures
The following types of index futures are available:
- Nifty 50: The NSE’s Sensitive Index or Sensex is composed of 50 underlying securities.
- Nifty IT: The underlying assets are shares of information technology companies. These futures would be affected by the overall performance of the sector.
- S&P BSE Sensex: There are 30 securities that make up the BSE’s Sensitive Index or Sensex.
- Nifty Bank: The index is composed of bank shares, so futures for the Nifty Bank would be affected by the performance of the banks.
- S&P BSE Bankex: The Sensex index includes banking stocks in the futures.
- S&P BSE Sensex 50: It includes 50 stocks instead of the 30 that make up the Sensex.
- S&P BSE Bharat 22 Index: The index consists of 22 central public sector enterprises.
Importance of the Index Futures
Futures contracts are an effective way to trade stocks when there is a lack of cash to purchase large quantities of stock. This is a derivative-based investment that allows traders to spend less and earn more. In addition, there are two ways to use futures contracts on shares and stock indexes. However, it is important to choose the best mobile trading app when trading derivatives to ensure a smooth trading process.
A futures contract can be used by experienced traders to predict the future direction of an underlying asset or index. This means investors can trade on a group of assets by predicting whether the market will be bullish or bearish instead of buying or selling futures contracts. The best way to lock in successful positions when speculating is to stay on top of market developments.
In order to hedge against losses associated with excessive stock price swings, many traders use futures contracts. To reduce their risk of losing money, investors with stock portfolios or equity index options sell futures contracts when stock prices fall. A futures contract gains value in this situation, rather than a stock contract losing value.
In the financial markets, index futures offer traders diverse opportunities for speculation and risk management. By using these financial instruments, traders can buy or sell financial indices at a predetermined price.
Contracts based on index futures involve a commitment to deliver the cash value based on the underlying index at a specified future date. By speculating on the direction of the market or hedging against losses, traders can gain exposure to indices such as Nifty50, Nifty IT, and S&P BSE Sensex.