Stock Index Futures
Stock index futures contracts began trading on February 24, 1982, when the Kansas City Board of Trade introduced futures on the Value Line Index. About two months later, the Chicago Mercantile Exchange introduced futures contracts on the S&P 500 Index. By 1986, the S&P 500 futures contract had become the second most actively traded futures contract in the world, with over 19.5 million contracts traded in that year.1 In May 1982, the NYSE Composite Index futures contract began trading on the New York Futures Exchange. In July 1984, the Chicago Board of Trade, frustrated because Dow Jones & Company went to court to block its attempts to trade futures on the Dow Jones Industrial Average (DJIA), finally gave up and began trading futures contracts on the Major Market Index (MMI). The MMI was very similar to the DJIA. Finally, in June 1997, Dow Jones agreed to allow DJIA options, futures, and options on futures to begin trading. On October 6, 1997, futures on the DJIA began trading on the Chicago Board of Trade.
In their short history of trading, stock index futures contracts have had a great impact on the world's equity markets. Trading in stock index futures has allegedly made the world's stock markets more volatile than ever before. Critics also claim that individual investors have been driven out of the equity markets because institutional traders' actions in both the spot and futures markets cause stock values to gyrate with no links to their fundamental values. Many political figures have called for greater regulation, going so far as to favor an outright ban on stock index futures trading. Fortunately, such extreme measures have been avoided. Stock index futures have become irreplaceable in our modern world of institutional money management. They have revolutionized the art and science of equity portfolio management as practiced by mutual funds, pension plans, endowments, insurance companies, and other money managers.
A futures contract on a stock market index represents the right and obligation to buy or sell a portfolio of stocks characterized by the index. Stock index futures are cash settled. Thus, there is no delivery of the underlying stocks. The contracts are marked to market daily, and the futures price is set equal to the spot index level on the last trading day, leaving one last mark-to-market cash flow.
Figure 6.5 showed only some of the wide range of stock index futures contracts that trade globally, including those on the U.S., Japanese, French, British, German, and Australian stock markets. The most actively traded contract is the S&P 500 futures contract, traded on the CME.
We begin this chapter with a discussion of how different indexes are computed.
An index is, in one sense, just a number that is computed to allow measurement of the value of a portfolio of stocks. Other indexes have been constructed to track the values of securities of other