Summary
- In a futures contract, the buyer agrees to buy a specific asset from the seller in the future. The price at which the asset is sold for (in the future) is agreed upon today.
- One of the main advantages of buying futures contracts is that there are considerably lower transaction costs involved in predicting the movement of a stock when compared to purchasing the actual stocks themselves.
- In the case of the S&P/ASX 200 index, the owner of a futures contract receives AU$25 for each index point it is trading at an agreed-upon time at a specific time in the future.
Many investors can be confused over what a futures contract represents and how it works, let alone what an SPI futures contract represents.
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So, let us break it down.
Futures Contracts
In a futures contract, the buyer agrees to buy a certain asset from the seller at a point in the future. The price at which the asset is sold for (in the future) is agreed upon in the present day.
So essentially, the buyer is betting on the price of an asset going below the predetermined agreed-upon price. In contrast, the seller is betting that the asset’s price will go above the predetermined agreed-upon price. Futures contracts are also known as “derivatives” due to the fact that the value of futures contracts is derived from the value of other assets.
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One of the main advantages of buying futures contracts is that there are considerably lower transaction costs involved in predicting the movement of a stock when compared to purchasing the actual stocks themselves.
Another helpful factor of futures investment is the small initial outlay required by the investor and the simple process involved in closing out that trade.
In short, futures trading is easier and more cost-effective than investing directly in stocks.
Futures contracts are available worldwide across many different assets, such as stocks, commodities, and fixed income markets.
The SPI Index
In the case of the S&P/ASX 200 index, the ASX SPI 200 futures contract owner receives AU$25 for each index point it is trading at an agreed-upon time at a specific time in the future. So, for example, if the S&P/ASX 200 is trading at 1000 points in the agreed-upon future expiration date, that particular contract would be worth AU$25,000.
Betting on Stock Futures
As mentioned, the price of a futures contract is based upon the investor’s vision of where the market is heading. The investor can be accurate or way off target given that unforeseen events, like a declaration of war or the impeachment of a sitting president (something America has experienced in recent times) can significantly impact the market.
A stock index futures is unique given that it is literally thousands of contracts representing the views of thousands of traders as to where the market is headed at any given point in the future.
Stock futures can be a good source of predicting where the market is headed. For example, if traders are offering lots of contracts higher than yesterday’s closing price, it can be a sign that the market will rise the following day.
However, even without an external influence like a catastrophe or a war, these predictions can still be wildly off base. Therefore, although futures can be a valuable source of information, traders should look for alternative sources of information before making any stock futures bets.
The ASX SPI Futures market trading hours are from 5:10 PM - 7:00 AM and 9:50 AM - 4:30 PM (Australian wintertime), and 5:10 PM - 8:00 AM and 9:50 AM - 4:30 PM (Australian summertime).
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