A futures contract on the stock market index gives its owner the right and obligation to buy or sell the portfolio of stocks characterized by the index. Stock index futures are cash settled; there is no delivery of the underlying stocks.
In their short history of trading, index futures have had a great impact on the world’s securities markets. Indeed, index futures trading has been accused of making the world’s stock markets more volatile than ever before.
The critics claim that individual investors have been driven out to the equity markets because the actions of institutional traders in both the spot and futures markets cause stock values to gyrate with no links to their fundamental values. Whether stock index futures trading is a blessing or a curse is debatable.
It is certainly true, however, that its existence has revolutionized the art and science of institutional equity portfolio management.
The main differences between commodity and equity index futures are that: _
• There are no costs of storage involved in holding equity.
• Equity comes with a dividend stream, which is a negative cost if you are long the stock and a positive cost if you are short the stock.
Therefore, Cost of carry = Financing cost - Dividends
Thus, a crucial aspect of dealing with equity futures as opposed to commodity futures is an accurate forecasting of dividends. The better the forecast of dividend offered by a security, the better is the estimate of the futures price.
In their short history of trading, index futures have had a great impact on the world’s securities markets. Indeed, index futures trading has been accused of making the world’s stock markets more volatile than ever before.
The critics claim that individual investors have been driven out to the equity markets because the actions of institutional traders in both the spot and futures markets cause stock values to gyrate with no links to their fundamental values. Whether stock index futures trading is a blessing or a curse is debatable.
It is certainly true, however, that its existence has revolutionized the art and science of institutional equity portfolio management.
The main differences between commodity and equity index futures are that: _
• There are no costs of storage involved in holding equity.
• Equity comes with a dividend stream, which is a negative cost if you are long the stock and a positive cost if you are short the stock.
Therefore, Cost of carry = Financing cost - Dividends
Thus, a crucial aspect of dealing with equity futures as opposed to commodity futures is an accurate forecasting of dividends. The better the forecast of dividend offered by a security, the better is the estimate of the futures price.