Dow Jones futures are commodity trades that involve specified pricing and delivery dates in the future. They allow investors to predict or speculate on the future value of equities prior to the opening bell.
Definition and Example of Dow Jones Futures
Commodities trade can be seen in the Dow Jones Industrial Average (DJIA) and the Standard & Poor’s (S&P) 500 indexes. Instead of buying securities, you can trade commodities futures contracts on the index.
If you are unfamiliar with the futures market, Dow Futures may seem perplexing at first. Here are some fundamentals to help you understand.
How Dow Jones Futures Work?
Consider a farmer and a grocer to help you understand how Dow Futures work. The grocer knows that the farmer will soon have a crop of soybeans to harvest, so they offer to buy 100 bushels of soybeans for $900 in January.
If the farmer accepts, the contract is signed, and both parties await January. Whatever the price of soybeans is in January, the grocer pays that price.
A futures contract is a legally binding agreement between two parties (individuals or institutions) to exchange money or assets based on the expected prices of an underlying index.
Futures are not the same as futures options. Options are derivatives of the futures market that have their own market and exchange. Option contracts are purchased to allow the holder the right, but not the duty, to exercise the terms of a commodity contract. In a futures contract, both parties are required to fulfil their obligations.
Where Do Dow Jones Futures Trade?
The purchase price you agreed on with the seller determines your position in a deal. Dow Futures contracts are traded on an exchange, which means you deal with the exchange when you create your position (your price and contract) on the commodity.
The exchange exists to keep trading fair and to remove risk, such as one side failing to fulfil a contract. This risk is minimised by clearing all futures contracts through the exchange, as the exchange serves to guarantee every position.
When Can You Trade Dow Jones Futures?
Every day, at 7:20 a.m. Central Time (8:20 a.m. Eastern Time), Dow Futures begin trading on the Chicago Board of Trade (CBOT), one hour and ten minutes before the stock market opens.
This allows trade to occur, allowing reporters and professionals to gauge market sentiment (investors’ attitudes towards pricing and market potential).
Market sentiment is volatile—if a company produces big earnings and the Dow Futures surge, chances are the stock market will increase as well. If an unexpected weather occurrence causes major shipping lanes to be closed before the stock market starts, the Dow Futures may fall as investors begin to anticipate problems. As a result, stocks might drop after the opening bell rings.
Buying Futures With Leverage
Dow Futures have built-in leverage, which means that traders can trade futures with much less money while reaping exponential profits or losses. This can allow traders to profit significantly more from market price fluctuations than they could by buying a stock altogether.
Dow Jones futures use a multiplier of ten (sometimes known as 10 to one leverage or 1,000% leverage). If Dow Futures are now trading at 6,000, a single futures contract has a market value of $60,000. A single Dow Futures contract increases or decreases by $10 for every $1 (or “point” as it is known on Wall Street) that the DJIA moves.
As a result, a trader who felt the market would rally could simply purchase Dow Futures with less money and benefit greatly due to the leverage effect.
If the market rose to 14,000 from its present level of 8,000, each Dow Futures contract would be worth $60,000 (6,000 point rise x 10 leverage factor = $60,000). It’s worth mentioning that the opposite is also possible. If the market falls, the Dow Futures trader could lose a lot of money.
Source: https://www.thebalancemoney.com/what-are-dow-futures-and-how-do-they-work-358089
