What is a Dow Jones future?
A Dow Jones future is a legally binding agreement between two parties that stipulates at which price they will exchange the value of the Dow Jones Industrial Average (DJIA) stock index (in cash) on a later date of expiry.
Unlike most futures contracts, the price of Dow futures are not based on a physical asset, but rather an index, which is nothing more than a number representing a group of stocks. In this case, the Dow Jones is a price-weighted average of the 30 most significant companies in the US. The companies are the largest in the US in terms of price per share, not market capitalisation.
Constituents of the index span nine sectors from industrials to healthcare, which include world-famous stocks like UnitedHealth Group, Goldman Sachs and Home Depo, as well as other household names like Apple, Boeing and McDonald’s.
Learn more about the Dow Jones index
The Dow Jones is often referred to as Wall Street, because it’s become so synonymous with the US stock market itself. However, it’s important to note that the S&P 500 has a broader cross section of the US equity market.
Dow Jones futures contracts are traded on the Chicago Mercantile Exchange. The instrument was created to enable investors and traders to speculate on the future value of the stocks that make up the Dow ahead of market open.
For example, say a company releases above-expectations earnings, traders have a pretty good idea that when the market opens the share price will rise. They could take advantage of the current difference by opening a futures position to buy the stock at the current price, and then sell it later at the new, higher price.
Dow futures contracts are traded on exchanges to keep them regulated and reduce counterparty risk. The exchange would step in if one party was unable to fulfil their end of the contract.
How are Dow Jones futures calculated?
Dow Jones futures are calculated using a multiplier of 10, which is known as leverage. So, if the stocks of the Dow Jones are currently trading at a combined value of 3,000 points, a single contract would be worth $30,000. For every point of movement in the index, a Dow futures contract will increase or decrease by $10.
The leveraged nature of Dow futures enable you to get a much larger exposure to the US stock market than would otherwise be possible. However, it also magnifies your risk – a fall of just 100 points could wipe out $10,000 of your position.
The DJIA itself is calculated using the share prices of each constituent, which are added together and divided by …….