Most people who follow the financial markets are aware that events in Asia and Europe can have an impact on the US market. How many times have you awoken to CNBC or Bloomberg reporting that European markets are down 2%, that futures are pointing to a weaker open, and that markets are trading below fair value? What happens on the other side of the world can influence markets in a global economy. This could be one of the reasons why the S&P 500, Dow 30, and NASDAQ 100 indexes open with a gap up or down.
The indices are a real-time (live) depiction of the equities that make up the portfolio. Only during the NYSE trading hours (09:3016:00 ET) do the indexes indicate the current value of the index. This means that the indexes trade for 61/2 hours of the day, or 27% of the time, during a 24-hour day. That means that 73 percent of the time, the markets in the United States do not reflect what is going on in the rest of the world. Because our stocks have been traded on exchanges throughout the world and have been pushed up or down during international markets, this time gap is what causes our markets in the United States to gap up or gap down at the open. Until the markets open in New York, the US indices “don’t see” that movement. It is necessary to have an indicator that monitors the marketplace 24 hours a day. The futures markets come into play here.
Index futures are a derivative of the indexes themselves. Futures are contracts that look into the future to “lock in” a price or predict where something will be in the future; hence the term. We can observe index futures to obtain a sense of market direction because index futures (S&P 500, Dow 30, NASDAQ 100, Russell 2000) trade practically 24 hours a day. Futures prices will fluctuate depending on which part of the world is open at the time, so the 24-hour market must be separated into time segments to determine which time zone and geographic location is having the most impact on the market at any given moment.
What is the purpose of futures?
- Futures are financial derivative contracts in which the buyer agrees to acquire an asset and the seller agrees to sell an asset at a defined future date and price.
- An investor can speculate on the direction of an asset, commodity, or financial instrument via a futures contract.
- Futures are used to protect against losses caused by unfavorable price movements by hedging the price movement of the underlying asset.
Is the stock market predicted by futures?
Stock futures are more of a bet than a prediction. A stock futures contract is an agreement to buy or sell a stock at a specific price at a future date, independent of its current value. Futures contract prices are determined by where investors believe the market is headed.
When do stock futures trade?
- Stock index futures, such as the S&P 500 E-mini Futures (ES), reflect expectations for a stock index’s price at a later date, based on dividends and interest rates.
- Index futures are two-party agreements that are considered a zero-sum game because when one party wins, the other loses, and there is no net wealth transfer.
- While the stock market in the United States is most busy from 9:30 a.m. to 4:00 p.m. ET, stock index futures trade almost continuously.
- Outside of normal market hours, the rise or fall in index futures is frequently utilized as a predictor of whether the stock market will open higher or lower the next day.
- Arbitrageurs use buy and sell programs in the stock market to profit from price differences between index futures and fair value.
What is the distinction between the Dow and the Dow futures?
Dow futures are financial futures that allow investors to hedge or speculate on the future value of various Dow Jones Industrial Average market index components. E-mini Dow Futures are futures instruments generated from the Dow Jones Industrial Average.
How do you interpret the future?
- Change: The difference between the current trading session’s closing price and the previous trading session’s closing price. This is frequently expressed as a monetary value (the price) as well as a percentage value.
- 52-Week High/Low: The contract’s highest and lowest prices in the last 52 weeks.
- Each futures contract has a unique name/code that describes what it is and when it will expire. Because there are several contracts traded throughout the year, all of which are set to expire, this is the case.
WHAT IS HEDGING?
When the price of metal fluctuates, it might result in a profit or a loss, which has an impact on the bottom line. Metal producers (producers) and enterprises that make products out of metal (consumers) are frequently affected by metal price variations. This is frequently referred to as “exposure” to metal prices. Hedging is used to reduce price exposure and insulate a company’s performance from market fluctuations.
A company’s pricing exposure might alter regularly in the usual course of operations. Holding extra inventory, for example, puts a corporation at risk of financial loss if its value declines as a result of a drop in market pricing. If a corporation pledges to future sales at a set price, on the other hand, it exposes itself to the risk of rising metal input costs.
A business might choose to accept these risks or to take a more proactive strategy and manage them. Physical or financial hedges might be used as part of this “risk management.”
Physical hedging is the practice of pricing physical material that has been purchased or sold to match the price of future production and sales. Back-to-back pricing is what it’s called.
Financial hedging is the process of reducing price risk by utilizing a financial derivative (such as a future or option) to offset the price movement of a physical transaction.
PHYSICAL AND FINANCIAL HEDGING
Metal producers and consumers are frequently required to commit to a predetermined price for their final product for future delivery in order to obtain a client order. Most manufacturers and consumers want to avoid having big inventories, therefore they will only make the finished product as near to the delivery date as possible. However, this exposes them to danger.
Between the day they agreed on the fixed-priced sale and the date they buy the metal, the price of the metal they need to manufacture their finished product may rise (or fall). If the price of metal rises during this time, the corporation may suffer large losses.
Let’s take the case of ABC Corp, a fictitious aluminum equipment manufacturer.
ABC Corp contracts to sell aluminum boxes to XYZ Ltd for a set price of US$1900 per metric tonne (mt) with a six-month delivery date.
- a) Purchase metal on the spot market and receive it practically immediately. This isn’t ideal because it leaves ABC Corp with a lot of inventory and the costs of financing, storing, and insuring it.
- b) Negotiate a fixed-price contract with a physical aluminum supplier for future delivery. This may not be the greatest option because physical vendors may charge a premium for taking on the price risk. Furthermore, if market prices swing too far in favor of ABC Corp, physical fixed-price delivery agreements are vulnerable to the risk that a supplier may not honor the agreement (performance risk).
ABC Corp does not incur price risk in either of these cases of physical hedging, but it must consider other factors such as performance risk and inventory expenses.
- c) Purchase the appropriate metal on the spot market immediately before production begins.
However, until the metal is supplied, ABC Corp will be exposed to the metal price in both circumstances. Financial hedging can be beneficial in such a case.
The risk in cases c) and d) stems from a time difference between XYZ Ltd’s fixed-price order and the moment when ABC Corp has the physical metal. This is illustrated in the graph below:
The graph depicts the potential for loss as a result of such a commitment, as well as the necessity to consider how to effectively manage risk. A detailed examination of the data supports this conclusion.
The highest price difference over a four-month (120 calendar-day) period has ranged between -48.1 percent and +42.1 percent in the last 15 years. The price variance over a four-month period is almost flat at -0.2 percent on average, while the standard deviation is 12.5 percent. This demonstrates how big price swings can be.
Why are futures traded?
Futures are significant tools for hedging and managing various types of risk. Foreign-trade companies utilize futures to manage foreign exchange risk, interest rate risk (by locking in a rate in expectation of a rate drop if they have a large investment to make), and price risk (by locking in prices of commodities such as oil, crops, and metals that act as inputs). Futures and derivatives help to improve the efficiency of the underlying market by lowering the unanticipated costs of buying an item outright. Going long in S&P 500 futures, for example, is far cheaper and more efficient than buying every company in the index.
What is the minimum amount of money required for future trading?
If you assume you’ll need to employ a four-tick stop loss (the stop loss is four ticks distant from the entry price), the minimum you should risk on a trade in this market is $50, or four times $12.50. The minimum account balance, according to the 1% rule, should be at least $5,000 and preferably higher. If you want to risk a larger sum on each trade or take more than one contract, you’ll need a bigger account. The recommended balance for trading two contracts with this method is $10,000.
How do Nasdaq 100 futures work?
The Nasdaq 100 futures are commodities futures traded in the stock futures market. The e-mini Nasdaq 100 and the Nasdaq 100 are the two most popular products, both of which track a basket of the largest 100 non-financial firms listed on the Nasdaq exchange (the Nasdaq 100 index). Due to its low cost of transaction and huge volume, the e-mini Nasdaq 100 is the most popular among Nasdaq futures traders.