Dow Futures is one of the most widely traded indexes in the equity markets. Investors use the index to predict and get a feel of how the Dow Jones Industrial Average Index or broader stock market will perform aftermarket open.
Like all the futures contracts, the Dow Futures is a contract between two investors traded in the options exchange. The exchange acts as the intermediary between two individuals or institutions using the Dow Futures contract to bet on which direction the DJIA will move.
The Dow Future contract begins trading at 7:20 am Central time nearly an hour and ten minutes before the actual market opens.
Before the markets open, you’ll likely hear news reports say how Dow Futures are trading, i.e. Dow futures are down, or Dow futures are up. The actions that take place in the options market helps predict how the market is likely to open.
How Dow Futures Contract Work
A future is a contract that stipulates the buying or selling price point of a commodity at a specific price point at a time in future. The contracts are mostly used in commodities such as oil, soybeans, corn etc. The Dow Futures is based on the DJIA index, which tracks 30 of the biggest stocks in the U.S. The value of each Dow Futures contract is normally 10 times the value of the DJIA.
Likewise, if the DJIA index is trading at $11,000, the Dow Futures will be valued at $110,000. Similarly, the DJIA increasing by one point will cause the DJIA to increase by $10.
Dow Futures work on the same principle as other futures contract whereby the price of an item is agreed at the moment but paid at a future date regardless of the prevailing price. Consider a farmer who has a crop of Soybeans in a farm. In a bid to protect one against price fluctuations in future, the farmer can agree to sell the crop before it is harvested.
In this case, a buyer can agree to buy the crop say 200 bushels of soybeans at $1800. If the farmer agrees, the contract will be made. In this case, the farmer will have to deliver the crop at $1800 regardless of whether the price will have risen or fallen at that time. Likewise, the buyer will have to pay the agreed-on amount.
Conversely, a futures contract is a binding agreement whereby two parties agree to exchange money and assets based on predicted prices.
Dow Futures Role
The fact that Dow Futures starts trading before the actual markets open provides insights on how the market is likely to perform in advance. Likewise, the investment community relies on the index to get a sense of the market’s general mood.
Whenever the Dow Futures contracts are trading lower, the likelihood of the stock market opening lower is usually high. Similarly, whenever the Dow Futures are trading higher before the market opens the likelihood of markets opening higher is usually high.
Dow Futures Risks
The fact that Dow Futures trade with leverage of 10 makes it a double-edged sword. Similarly, whenever the index is moving in favor, profits get multiplied by ten. Likewise, whenever it is going against, losses accumulate exponentially given the ten multiple
