You’ve heard about them in the news, you’ve heard they’re easy to trade, but what exactly are index products?
First, let’s define an index. Simply put, an index represents a “basket” or portfolio of stocks or commodities, grouped in a particular way (e.g., the S&P 500 Index is made up of large-capitalization stocks; the Russell 2000® Index is based on small-capitalization stocks). How a particular stock or commodity index tracks the market depends on its composition – the stocks or commodities included in the index, the percentage weight of each component, and the method of calculating each index. The index comprising these stocks or commodities is typically called the “underlying” or “cash.”
Index futures and options closely follow the price movement of these underlying indexes. Index futures are a type of forward contract, which means they are agreements to buy or sell their underlying product at a specific price on a specific date in the future.
E-mini S&P 500 and E-mini Nasdaq-100 stock index futures are electronically traded, smaller versions of the stock index futures contracts used by the big financial institutions. (The “E” stands for electronic, and the “mini” refers to the smaller size of these investment tools.) At one-fifth the size of their institutional counterparts (also traded at CME), they can be easily used by individual investors. They provide a highly liquid way to trade stock indexes.
From a practical standpoint, they trade similarly to stocks. You can go long (buy) and then close out your trade by selling. It’s also just as easy for an individual investor to sell first then buy back at a hopefully lower price. That’s called shorting and it is important that you know that by buying your losses can go no lower than zero, but if you are shorting your downside is unlimited. You can buy an E-mini stock index contract – an advantage over trading stocks. As futures contracts on stock indexes, these E-minis trade at a price that is closely related to the underlying stock market index on a day-to-day basis. Like other futures, these products are a type of forward contract. This means they are agreements to buy or sell their underlying product at a specific price on a specific date in the future.
When you trade these products, you are trading on the future direction of the underlying stock indexes. E-mini stock index prices fluctuate as the stock markets move – almost constantly. As a result, these contracts offer virtually endless trading opportunities. Similar to the stock market, you execute these trades via a registered broker over the phone or with electronic order management software on your PC.