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Benefits and risks

Benefits

ASX index futures provide you with exposure to an index's movement for a limited period of time. You can use futures as part of a strategy integrated with your share investments, or in isolation.

Gain exposure to the broad sharemarket or to a market sector

ASX index futures enable you to trade a view on the broad sharemarket, or on a market sector, in one transaction. Instead of trying to construct a portfolio of shares that make up the index, or choosing a stock that you believe will move in line with the broader market, you can take a position using an index futures contract.

Hedge a physical position

You can sell futures to hedge a portfolio of shares. By selling futures, would benefit from a decline in the value of the futures contract which may offset some of the loss of value in the portfolio of shares that make up the index, or choosing a stock that you believe will move in line with the broader market, you can take a position using an index futures contract.

It is important to remember that the success of a hedging strategy will depend in part on how closely movements in the value of your portfolio track movements in the index underlying the futures contract. This is often referred to as basis risk.

Trade declining markets

Share investors are used to making money only in rising markets. If your view on the market or on an individual stock turns negative, your choices traditionally have been either to sell your shares or to take no action and wait for the market to recover.

With ASX futures you can profit in falling markets. If you have a bearish view on the market as a whole, you can sell index futures. If the market then falls as predicted, you could take profits by closing out your position in those index futures or, maintain your position until maturity of the contract and receive a positive cash settlement.

Achieve leveraged returns

When you trade a futures contract, your initial outlay is only a small percentage of the value of the contract. If the market moves in your favour, the percentage returns you could make from trading the futures contract might be significantly higher than the move in the underlying index itself.

Risks

In planning any futures strategy, it is important to consider the risks of futures trading.

Leveraged losses

The leveraged exposure provided by futures can lead to substantial losses.

At the time of your opening transaction, your outlay is limited to the initial margin. This means that the percentage return, either positive or negative, made on your initial investment may be far greater than the movement in the underlying index. Therefore, the market moves against you, the losses you might suffer from trading futures could be substantial.

Unlike option contracts, where the financial cost to the buyer of the option may be limited to the cost of the premium, both the buyer and the seller of a futures contract face potentially unlimited losses. The ASX index futures contracts are legally binding agreements to buy or sell the relevant underlying index at the agreed price.

You should discuss with your investment adviser whether this risk is appropriate to your circumstances.

Hedging imperfections

You may use index futures to hedge against the risk of either a rise or a fall in the underlying index. By selling index futures you can protect the value of a share portfolio. By buying index futures you can lock in the purchase price of the index at a future date.

The principle behind using futures to hedge is that a profit in one market, say the futures market, will offset a loss in the other market, the share market.

The success of any hedging strategy depends in part on how closely movements in the value of the shares being hedged track movements in the index underlying the futures contract. This is often referred to as basis risk.

For example, you may sell ASX SPI 200 futures to lock in the value of your share portfolio. Even though your portfolio may contain a number of the shares in the S&P/ASX 200 index, it is unlikely to move exactly in line with the index. The change in value in your portfolio may not be offset exactly by the change in value of the futures contract. This may work in your favour, or it may work against you.

Another consideration is the amount you choose to hedge. The value of the share portfolio you wish to hedge may not equal an exact multiple of Index futures contracts. You will therefore have to choose between slightly over-hedging and slightly under-hedging your physical position.

Again, this discrepancy may work in your favour, or it may work against you, depending on how the market moves.

Risk disclosure statement

Your broker is required to give you certain information before allowing you to trade. Included in this information is a risk disclosure statement setting out risks associated with futures trading.

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