Five Things Every Investor Should Know About Index Futures

Opening indications for the stock market are frequently dictated by futures activity, which takes place after the prior trading day's close or overnight through early morning, before the new markets open.

So what?

The futures market is the quickest and easiest way for large asset managers (see portfolio manager ) and speculators to react to an event, such as a Federal Open Market Committee statement, a company report that significantly beats or misses earnings estimates (see earnings surprise ), a tragedy or some other major occurrence.

For these reasons, as an individual investor, you need to be more aware of the futures markets.

In the early to mid-1980s, working at Morgan Stanley MS, I was involved with the equity index arbitrage business while it was in its infancy, so I have a great deal of experience in futures. I thought that I would use this installment of "The Finance Professor" to describe five ways to better understand what index futures and index arbitrage are and how these futures can affect you.

1. What Index Futures Are

A futures contract is a highly leveraged derivative investment that is transacted by hedgers , speculators and arbitrageurs . The contract represents an obligation on the part of the seller to deliver an asset to the buyer in exchange for a predetermined price.