Index futures have been one of the latest innovations in the financial markets. This article explains in detail, the complete theoretical framework of index futures. It also discusses the growth and trends in the index futures market. The complexities involved in the trading mechanism of such products are also discussed at length. In essence, the article captures the pros and cons involved in index futures and their application.

Investigating the factors that determine the prices of stock index futures is quite exiting and reveling. Many studies have been conducted, to draw some relationship between the spot price (current market price) and the future prices of stock index futures. Index futures are similar to any other futures contracts except for delivery. Since the underlying asset is an index (e.g., the NIFTY Index or the BSE-30 Index) the contract is cash settled. Cash settlement forces the futures price to be equal to the cash price at the time of settlement because convergence between cash and futures is essential for hedges to be effective.

Futures contract derives its value from the underlying asset, in our case the stock index. The index in turn derives its value from the prices of securities that constitute the index and is created to represent the sentiments of the market as a whole or of a particular sector of the economy. Hence, predicting the prices of the index futures seems to be a difficult proposition in comparison to commodity futures and single stock futures. But it is worth making the effort because index futures are a user-friendly instrument for both professional futures traders, as well as individual investorsan understandable way to enter the derivatives market.

Index futures provide enormous flexibility to the investment portfolio, it creates the possibility of speculative gains using leverage (less capital commitment because of the existence of margining system) and it can be a substitute for a future stock or mutual fund transaction. To protect against a great decline in the stock market, money managers can hedge by selling index futures. One such hedging strategy that has received a great deal of popularity is Portfolio Insurance.

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