How Index Futures Work?
Index futures operate on the principles of futures contracts, acting as a legal agreement between two parties to buy or sell an index at a predetermined date and price. The buyer, also known as the long position holder, expects the index’s value to increase and profits from the price difference. Conversely, the seller, holding a short position, anticipates a decrease in the index’s value and profits if the price falls. The agreed-upon date is the expiration date of the contract, and the specified price is the futures price.
The value of index futures is closely tied to the performance of the underlying index. If the index rises, the long position holder profits, while the short position holder incurs a loss, and vice versa. Settlement of index futures can occur in two ways: physical delivery or cash settlement. Physical delivery involves the actual transfer of the underlying stocks to the buyer, while cash settlement involves the exchange of cash equal to the difference between the futures price and the actual index value at expiration.