CHAPTER 9Security Futures Products Introduction.ppt

Chapter 9 CHAPTER 9Security Futures Products Introduction Chapter 9 and 10 explore stock index futures. This chapter is organized into the following sections: Indexes Stock Index Futures Contracts Stock Index Futures Prices Index Arbitrage and Program Trading Speculating with Stock Index Futures Risk Management with Stock Index futures Indexes If you have insight into the future direction of the stock market, specifically one index or another, you may want to trade stock index futures. Stock index futures allow you to make a bet on which direction you think a stock market index is headed. Stock index futures also allow you to hedge various financial positions. Stock index futures trade on a number of different indexes. Indexes The various indexes use differing computational methods. To understand the trading and pricing of index futures, one must first understand a bit about how the underlying indexes are computed. Priced-Weighted Indexes In a price-weighted index, stocks with a higher price receive a larger weighting in the computations. Price-weighted indexes do not consider dividends paid by the stocks. The companies contained in these indexes change infrequently. Changes only occur as a result of special events like liquidations and mergers. In this section, the DJIA is used as a representative price-weighted index. The DJIA is comprised of 30 stocks. Table 9.1 shows the lists of stocks. DJIA Index Priced-Weighted Indexes The DJIA is computed by adding the share prices of the 30 stocks comprising the index and dividing by the DJIA divisor. The divisor is used to adjust for stock splits, mergers, stock dividends, and changes in the stocks included in the index. Index Divisor The index divisor is a computed number that keeps the index unchanged in the event of certain occurrences (e.g., dropping one company from the index and adding another company, mergers and stock splits). The DJIA can be computed by using the following formula: Priced-W