What Are Dow Jones Futures And How To Invest In Them
What Are Dow Jones Futures?
Futures are derivative instruments, which means that their value derives from the value of another financial instrument. In this case, the value of a Dow Jones Future contract derives from the value of The Dow Jones Industrial Average Index. In very simple words, a future contract is a negotiated deal between a buyer and a seller, on an exact day in the future. The buyer agrees to buy the contracted amount at a predetermined price and the seller agrees to sell under these conditions. So a Dow Jones Future is a standardized contract in which the two sides agree today to to make a future deal , for a certain amount of lots at a defined price. In most of the cases, the future deal ends up with no physical delivery of the contracted goods to be made. You can deliver to me 5 Dow 30 indexes for example. This is why, after the future contract expires, the buyer receives/pays just the difference between the predicted future price and the actual price when the contract expires. And this is not only how Dow Jones futures work, but also almost all futures contracts work the same way.
Example of future contracts in action:
Today’s price of the Dow 30 index is $17 000. You bet that the price after 6 months will be $17 500, so you decide to take advantage of this gain. You find a seller named Jane and she thinks that the price of the index will be $16 500 after 6 months. You both decide to make a contract in which you buy 1 future contract from Jane and the she sells this one future contract to you at the current price of the index of $17 000. You are both obliged to close the deal after 6 months, which means to make the opposite operation at the market price – you sell your contract to Jana and she buy it back from you at the price of the market when you contract expires. If the price of the index goes up after this period of time and reaches $17500, you will make a profit because you can sell your contract at this price and earn $500. Jane is obliged to pay you that price and she will lose $500. But if the price of the index falls to $16 500, you will lose $500, because Jane will pay you only this price. She will earn $500 in this case: