The impact of index futures trading on underlying stock index volatility empirical evidence from vietnam on VN30

STATE BANK OF VIETNAM

MINISTRY OF EDUCATION AND TRAINING

BANKING UNIVERSITY OF HO CHI MINH CITY
___________

LE CHI TRUNG

THE IMPACT OF INDEX FUTURES TRADING
ON UNDERLYING STOCK INDEX
VOLATILITY: EMPIRICAL EVIDENCE FROM
VIETNAM ON VN30

GRADUATION THESIS
MAJOR: FINANCE – BANKING
CODE: 7340201

HO CHI MINH CITY, 2018


STATE BANK OF VIETNAM

MINISTRY OF EDUCATION AND TRAINING

BANKING UNIVERSITY OF HO CHI MINH CITY
__________

LÊ CHÍ TRUNG

THE IMPACT OF INDEX FUTURES TRADING ON

UNDERLYING STOCK INDEX VOLATILITY:
EMPIRICAL EVIDENCE FROM VIETNAM ON
VN30
MAJOR: FINANCE – BANKING
CODE: 7340201

SUPERVISOR: MsC. NGUYỄN MINH NHẬT

HO CHI MINH CITY, MAY 2018


ACKNOWLEDGEMENT
A completed study would not be done without any assistance. Therefore, the
authors who conducted this research would like to express our deepest gratitude my
supervisors Nguyen Minh Nhat for his supports, encouragement, invaluable academic
advice. Since this is a relatively new field at the Banking University of Ho Chi Minh
City in particular and of Vietnam in general, so this study required a lot of expertise
and knowledge of social psychology in finance. Finally, I would like to dedicate my
concluding words to all friends and fellows of mine. Without their support, the work
could not be done successfully.
The author would like to undertake research projects with the topic name “The
Impact of Futures Trading on Underlying Spot Market Volatility: Empirical
Evidence from Vietnam on VN30”. The figures and references are cited from clear
source and unity in the references. The contents and results of this study have not
been published in any public works until the present time. The author would like to
be responsible for my commitment.

Ho Chi Minh City, May 2018
Student in charge

Le Chi Trung



i

ABSTRACT
The onset of derivatives in Viet Nam and futures trading in specific may cause
the concerns in the participants in market. Over the world investors have started using
derivatives to manage their risks and futures is one of the most effective one. Since
derivatives markets interact continuously with spot markets, the effect of derivatives
markets on spot market volatility has become an important research topic.
The present study tries to estimate the effect of introduction of futures index
on the underlying stock volatility in Vietnamese stock market. To estimate the effect
of introduction of derivatives on stock market, GARCH family models which are
known for their ability to model volatility. Using these models, the asymmetric nature
of stock returns and the volatility of stock returns on the introduction of derivatives
are checked. Most of the previous studies break the sample period into two subperiods, one period before the introduction of futures trading and one after that
introduction. In this paper, we are going to use the same approach. In order to capture
the volatility, we apply at the same time the EGARCH (1,1), GARCH (1,1) models
for the pre-futures period and the post-futures period as well. The results of this study
indicate that the introduction of futures leads to a change in the spot market volatility
of the VN30 index but not significant and there is also the existence of leverage effect
and huge difference of ARCH and GARCH effect impact on spot price volatility in
each sub-period


ii

ABBREVIATION

WORDS
GARCH
EGARCH
IGARCH
ARCH
OLS
FTSE
SSC
HNX
BIST
HOSE
NSE
CSI
HSCEI
A50

MEANINGS
Generalized Autoregressive Conditional
Heteroskedasticity
Exponential Generalized Autoregressive Conditional
Heteroskedasticity
Integrated Generalized Autoregressive Conditional
Heteroskedasticity
Autoregressive Conditional Heteroskedasticity
Ordinary Least Squares
London Stock Exchange
State Securities Commission
Hanoi Stock Exchange
Borsa Instanbul Exchange
Ho Chi Minh Stock Exchange

National Stock Exchange of India
Stocks traded in the Shanghai and Shenzhen stock
exchanges
Hang Seng China Enterprises Index
Top 50 companies in the Shanghai Stock Exchange


iii

LIST OF TABLE

Table 2.1. Some typical previous research with GARCH Family models ... 27
Table 4.1. Descriptive and statistics of VN30 closing price in 10/2/2012 –
17/4/2018 ................................................................................................................ 43
Figure 4.2. VN30 Daily Closing Price Chart ......................................................... 43
Figure 4.3. VN30 Daily Logarithm Return Chart .................................................. 44
Table 4.4. Descriptive and statistics of VN30’s return in 10/2/2012 – 17/4/2018.
................................................................................................................................ 45
Table 4.5. Heteroskedasticity Test: ARCH Effect at latency 1 .......................... 46
Table 4.6. Heteroskedasticity Test: ARCH Effect at latency 7 .......................... 46
Table 4.7. Standard GARCH (1,1) model with dummy variable ........................ 47
Table 4.8. Standard GARCH (1,1) model in two sub-period ............................. 47
Table 4.9. Standard EGARCH (1,1) model with dummy variable ........................ 48
Table 4.10. Standard EGARCH (1,1) model in two sub-period ............................ 50


iv

TABLE OF CONTENT

ABSTRACT ....................................................................................................................i
ABBREVIATION ......................................................................................................... ii
LIST OF TABLE ......................................................................................................... iii
CHAPTER 1: INTRODUCTION ................................................................................ 1
1.1.

Necessity of the topic ...................................................................................1

1.2. Objectives and research questions ................................................................3
1.2.1. Objectives ..................................................................................................3
1.2.2. Research questions ...................................................................................4
1.3.

Research methodology ................................................................................4

1.4.

Subject of the research ................................................................................5

1.5.

Scope of research .........................................................................................6

1.6.

Significance of study ....................................................................................6

1.7.

Thesis structure............................................................................................7

CHAPTER 2: THEORETICAL FRAMEWORK AND LITERATURE REVIEW .......... 9

2.1. An overview of futures contract ....................................................................9
2.1.1. Futures contract definition ......................................................................9
2.1.2. Development of futures trading over the world ..................................10
2.2. Stock Index Futures Trading .......................................................................12
2.2.1. Index futures trading definition ............................................................12
2.2.2. The onset of futures trading in Vietnam ..............................................14
2.3. Stock index volatility ....................................................................................16
2.3.1. Stock index in Vietnam ..........................................................................16


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2.3.2. Spot price volatility ................................................................................17
2.4. Theoretical research basis ............................................................................19
2.4.1. Review previous researches on impact of futures trading on spot
market ................................................................................................................19
2.4.1.1. Impact of futures trading on spot price volatility in emerging
market countries ...........................................................................................19
2.4.1.2. Impact of futures trading on spot price volatility in developed
market countries ...........................................................................................22
2.4.4. General approaches in previous studies ...............................................25
2.4.4.1. Determination the impact of futures trading on spot price
volatility..........................................................................................................25
2.4.4.2. Determination how spot price volatility has been impacted in two
sub-period ......................................................................................................27
2.4.5. Gaps of previous studies ........................................................................30
CHAPTER 3: DATA AND METHODOLOGY ....................................................... 32

3.1. Generalized Autoregressive Conditional Heteroskedasticity (GRACH)
model .....................................................................................................................32
3.2. Exponential GARCH model - EGARCH(1,1) ............................................34
3.3. Testing for ARCH effect ..............................................................................35
3.4. Data processing .............................................................................................36
3.5. Research model .............................................................................................37
3.6. Hypothesis......................................................................................................41
CHAPTER 4: RESULTS AND DISCUSSION OF RESULTS ............................... 43
4.1. Descriptive statistics .....................................................................................43
4.2. Testing of ARCH effect on the set of data ..................................................45


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4.3. Empirical findings and results of estimation of GARCH model ..............47
4.3.1 Results on existence of the impact of futures trading introduction on
spot price volatility – GARCH (1,1) with dummy variable ..........................47
4.3.2. Results of GARCH estimation in two sub-period ...............................48
4.4. Empirical findings and results of estimation of EGARCH model ...........49
4.4.1. Results on existence of the impact of futures trading introduction on
spot price volatility – EGARCH (1,1) with dummy variable .......................49
4.4.2. Results of EGARCH estimation in two sub-period .............................50
4.4.3. Comparing with other emerging market countries ............................52
CHAPTER 5: CONCLUSION AND POLICY IMPLICATIONS ......................... 54
5.1. Conclusion .....................................................................................................54
5.2. Policy implications ........................................................................................55
5.3. Limitation and suggestion for further research.........................................57
REFERENCE .................................................................................................................i
APPENDIXES...............................................................................................................vi

vii



1

CHAPTER 1: INTRODUCTION

1.1.

Necessity of the topic
There has been widespread interest in the effects of futures trading on prices

in the underlying spot market. It has often been claimed that the onset of derivative
trading will destabilize the associated spot market and so lead to an increase in spot
price volatility in some market.
Considerable controversy exists over the influence of index futures trading on
the underlying stock market volatility. Concern over the impact of futures enhanced
following the stock market drop of October 1987 (Brady, 1988). Despite, there are
abundant of studies having been undertaken, there continues to be little agreement
on the effect that futures trading has on spot market volatility (see, for instance,
(Aggarawal, 1988), (Baldauf & Santoni, 1991),and (Antoniou & Holmes, 1995). Any
increase in stock market volatility that has followed the onset of futures trading has
generally been taken as justifying the traditional view that the introduction of futures
markets enhance destabilizing speculation.
The results from (Butterworth, 2000) reported for the Mid 250 index indicate
that while the existence of futures trading has made little impact on the underlying
level of volatility, as measured by the standard deviation, it has altered significantly
the structure of spot market volatility. Specifically, while there is evidence of more

information flowing into the spot market following the onset of trading, this new
information is impounded into prices less rapidly than before the onset of trading,
leading to an increase in the persistence of volatility.
The debate on this topic has become more heated when there are also some
findings proving that the introduction of futures has not caused impact on spot price
volatility. The results in (Antoniou & Holmes, 1995) suggest that futures trading has
led to increased volatility, but that the nature of volatility has not changed post-


2

futures. The finding of price changes being integrated pre-futures, but being
stationary post-futures, implies that the introduction of futures has improved the
speed and quality of information flowing to the spot market. Therefore, the
significance of findings on existence of futures contract’s effect on volatility spot
price is considered seriously in this research. Hence the evidence suggests that there
has been an increase in spot price volatility on a daily basis, but that this is due to
increased information in the market and not to speculators having adverse
destabilizing effects. Indeed, this increased volatility appears to be the result of
futures trading expanding the routes over which information can be conveyed to the
market.
There are some approaches the impact of futures index on spot market
volatility and GARCH model is usually utilized to detect the existence of futures
contract effect. (Sathya, 2009) study has been documented, however, that time series
returns for speculative markets show a clustering of fluctuations, i .e. larger changes
tend to be followed by large changes, and small by small of either sign. This appears
to be the case for NSE Nifty. Such observations question the validity of linear
regression models constructed under the assumption of homoscedasticity of the
variance. It is for this reason that GARCH, which allows for time-varying variance
in a process, is more appropriate to an analysis of volatility.

With the introduction of futures trading in the emerging market as Vietnam,
the estimation of the quality of the information flowing into the market and determine
how fast it can impound into the stock market volatility. More importantly, the impact
of the onset of futures trading is considered cautiously in this research using some
methodologies as previous studies. The initial findings in this field are concluded
when futures has just traded for only 9 months are also the foundation and base for
the further research and continue to review these result for the longer period and
develop in more fruitful and practical way.


3

Most of the previous studies done in the many financial markets (including
developed and emerging countries, where generally, focused on the impact of the
futures market on the spot market volatility. There were also some gaps and with
specific assumption for each nation. So, I want to conduct this research in the
Vietnamese market and make it initial study in this field and also compare results
with other countries categorized emerging, the specific objectives of this study are
presented in the following section.
1.2. Objectives and research questions

We try to make our objectives clear in this study and put more attention into
the main goals in order to have right direction to achieve the empirical findings with
the most effective methodology. We also refer the previous studies on the way how
they can set the ultimate goal in the same topic then the author apply and modify our
target to be appropriate in this research. The objectives after the author consider
cautiously will be presented in the following section

1.2.1. Objectives

Purpose 1: Determine the existence of impact of futures trading on the
volatility of the underlying spot market. If there is existence of futures trading impact
on volatility, this study’s finding is how spot price volatility is affected
Purpose 2: Find out whether the futures trading improves or decreases the
quality and speed of information flowing to spot markets thereby having deep
understanding on the market and propose the initiatives for stock market participants.


4

1.2.2. Research questions
First, is there the effect of introduction of futures contracts on spot price
volatility the effect of introduction of futures contracts on spot price volatility?
Second, if the existence of futures trading does affect volatility, how does it,
that is, what is the relationship between information and volatility following the onset
of futures trading?
Third, is the spot price volatility in Vietnamese market after the onset of
futures trading consistent with empirical findings in other emerging economy market
like Vietnam?
1.3.

Research methodology

When investigating the impact of futures trading on underlying spot market
volatility it is necessary to consider volatility both before and after the onset of futures
trading using an approach which is capable of detecting not only whether volatility
has changed but rather why it has changed. In addressing these issues, previous
studies

have

employed

the

Generalised

Autoregressive

Conditional

Heteroscedasticity (GARCH) family of techniques. By providing a detailed
specification of volatility these techniques enable the link between information and
volatility to be considered. I also use dummy variable to examine the statistical
significance of impact of futures trading on spot market volatility.
After that, more important than that how the onset of futures trading affect on
the volatility, the investigation utilized the GARCH family of statistical models to
investigate volatility in VN30 spot prices both before and after the onset of futures
trading. The standard GARCH (p, q) model introduced by Bollerslev suggests that
the conditional variance of returns is a linear function of lagged conditional variance
terms and past squared error terms.


5

In analyzing the relationship between information, spot price volatility and the
impact of futures trading, there are two issues that need to be addressed. First, does
the existence of futures trading in itself have any effect on volatility? Second, and
perhaps more important, if the existence of futures trading does affect volatility, how
does it, that is, what is the relationship between information and volatility following

the onset of futures trading? To address the first issue, we augment the conditional
variance equation with a dummy variable taking on the value zero pre-futures and
one post-futures. If the dummy is statistically significant then the existence of futures
trading has had an impact on spot market volatility. To address the second issue, the
period under investigation is partitioned into two sub-periods relating to before and
after futures trading began. GARCH models are estimated for both sub-periods,
thereby allowing a comparison of the nature of volatility before and after the onset of
futures trading (Antoniou & Holmes, 1995)
To analyze the effect of the introduction of futures contracts on spot price
volatility, both GARCH and EGARCH models are employed. Both of those models
are used in order to check the most appropriate models for our time series. Developed
by Bosselver and Taylor (1986), GARCH (p,q) model is used to capture better the
tendency of returns to exhibit volatility clustering of financial series. In this model,
positive and negative past values have a symmetric effect on the conditional variable

1.4.

Subject of the research
To inspect the impact of futures trading on the spot price volatility, the subject

of the research should be defined clearly which allow us to keep forward to the
ultimate goal. Thus, the subject in this research is the change or the volatility of spot
price in specific stocks in VN30 during both pre-futures and post-futures


6

1.5.

Scope of research

This study is going to examine the effect of futures trading on the spot market

volatility. Thus, the scope of this study just focus on the return volatility of stocks
which is in VN30 in period from February 2012 to April 20118.
In order to satisfy the requirements of statistical models we need an appropriate
period of time that why this study is going to study in the period from 10th February
2012 (when the onset of VN30 officially introduce to public) to 17th April 2018 which
is the most recent time from the introduction of futures to now. This period is
considered to cover the period from both pre and post-futures but it may cause the
imbalance for the separation of two sub-periods
1.6.

Significance of study
In the last decade, over the world many emerging and transition economies

have started introduction of derivative contracts, in the context of globalization, Viet
Nam’s economy has integrated immensely especially stock market has become the
attractive investment channel that draw attention from both many types of investors
and economists or researchers. In 2017, there is unforgettable milestone in Viet Nam
stock market history that is the onset of futures trading.
Trading on Top 30 market capital listed companies at Ho Chi Minh Stock
Exchange (Hose) was introduced on the August, 2017. The launch of derivative
products like index futures has significantly altered the movement of the prices in the
spot market. This research examines the impact of trading in the VN30 Stock Index
Futures on the volatility of the underlying spot market. To examine the relationship
between information and volatility (as subject neglected in previous studies) the
GARCH family of techniques is used.
Beside that the key contribution of this study is to find out the relationship
between the futures index with the volatility of spot market and does the onset of
futures trading in Vietnamese market really impact on the volatility of the spot market

7

putting in this context which there has been no research on this similar topic. Thus
the issue for this area of focus has been still controversy and especially the
consequences of spot market after the onset futures trading in Vietnamese market will
be also considered and compared with other consequences of the onset derivatives in
other countries (both emerging and developed countries).
In addition to finding of impact of futures trading on spot price volatility, I
also apply other method to overcome the drawbacks and gaps of the previous studies,
such as the restriction of parameters in GARCH model and only. In the presence of
an asymmetric response to news the standard GARCH model would be misspecified
leading to incorrect inferences regarding the relationship between information and
volatility. This in turn may result in inappropriate policy conclusions being drawn. In
these circumstances an alternative GARCH model is required to test for asymmetries,
to allow differentiation between the effects of good news and bad news on volatility.
These shortcomings are mentioned and the solutions are also suggested to address
issues in the following sections.
1.7.

Thesis structure
Chapter 1: Introduction
In this chapter, I focus on depicting and delivering my initial idea and how I
can execute the thesis step by step after figuring out the objectives of the thesis,
the subject of the thesis, the scope of the thesis,… Then we also raise the great
interest and significance of these in this field
Chapter 2: Theoretical framework and literature review
This chapter is the most important in the thesis since it can play the crucial
role in thesis and it is also important to readers perceive the general concept of

the author. We go through for the whole process from the beginning with general
concept to the details of definition such as futures definition, the futures contract
and especially the stock volatility. Moreover, we can show the results in previous


8

studies, how they apply the model to address issues and explanation for selecting
the appropriate models in capturing the volatility of VN30 stocks.
Chapter 3: Methodology and data
This chapter presents methodologies that are used for capturing the volatility
of spot price and determining the effect of futures trading on the spot price
market. In this chapter we provide the perception of GARCH model, its
advantages and disadvantages compared with other conventional models, we also
consider the GARCH family models and take it into account to overcoming the
drawbacks of GARCH. Furthermore, the asymmetric response is also addressed
using EGARCH models. The data samples and processing data are also expressed
in this chapter for readers easily follow up the thesis.
Chapter 4: Results and empirical findings
The empirical findings are also presented in this chapter when applying both
GARCH (1,1) and EGARCH (1,1) model in order to detect the impact of futures
trading. More importantly, the results in this chapter is really significant to
analyze and compare the empirical results regarding the ARCH and GARCH
effect in our model and how the information and news impact on the spot price
volatility after the introduction of futures. What is more, the results in this chapter
can show us the leverage effect in the market and confirm whether the existence
of asymmetric response in two sub-period or not.
Chapter 5: Conclusion and implication
The summary result and the connection between the empirical findings and
reality can be logically presented in this chapter. We also give some

recommendations that are based on experiences in the world, situation
in Vietnam, and results of this study. This chapter also goes to clarify its
limitations and suggests some new direction studies.


9

CHAPTER 2: THEORETICAL FRAMEWORK AND LITERATURE
REVIEW
2.1. An overview of futures contract
2.1.1. Futures contract definition

In finance,

a

futures

contract (more

colloquially, futures)

is

a

standardized forward contract, a legal agreement to buy or sell something at a
predetermined price at a specified time in the future. The asset transacted is usually a
commodity or financial instrument. The predetermined price the parties agree to buy
and sell the asset for is known as the forward price. The specified time in the future—

which is when delivery and payment occur—is known as the delivery date. Because
it is a function of an underlying asset, a futures contract is a derivative product.
(Durbin, 2010)
Contracts are negotiated at futures exchanges, which act as a marketplace
between buyers and sellers. The buyer of a contract is said to be long position holder,
and the selling party is said to be short position holder. As both parties risk their
counter-party walking away if the price goes against them, the contract may involve
both parties lodging a margin of the value of the contract with a mutually trusted third
party. However, futures contracts also offer opportunities for speculation in that a
trader who predicts that the price of an asset will move in a particular direction can
contract to buy or sell it in the future at a price which (if the prediction is correct) will
yield a profit. (Durbin, 2010)
The underlying asset in a futures contract could be commodities, stocks,
currencies, interest rates and bond. The futures contract is held at a recognized stock
exchange. The exchange acts as mediator and facilitator between the parties. In the
beginning both the parties are required by the exchange to put beforehand a nominal
account as part of contract known as the margin.


10

2.1.2. Development of futures trading over the world
Japan established the earliest recognized futures trading exchange in 1710 as
a way to trade rice futures. By 1710, merchants were trading futures contracts based
on the perceived future value of rice. 1710 is the official date at which the modern
futures exchanges market is thought to have begun. Why was a rice exchange so
important in Japan? Well, Japan’s feudal lords and samurai during this time period
weren’t paid in cash: they were paid in rice. That’s why the rice broker industry
became so important: samurai and feudal lords needed to exchange rice for cash, and
places like the Dojima Rice Exchange gave them a market in which to do it. In fact,

the brokers on the Dojima Rice Exchange are credited with introducing and spreading
paper money across Japan. They’re also credited with creating modern futures
exchanges.
In the 19th Century London was the Next Major Region to Employ Futures
Trading. Stock market trading in general is linked back to coffee houses in 16th
century London. English futures trading has similar origins, tracing its roots back to
the opening of London’s Royal Exchange in 1571. The London Metal Exchange –
known officially as the London Metal Market and Exchange Company – was founded
in 1877. This exchange was responsible for trading copper, lead, and zinc, firmly
establishing metals and ores as key commodities on futures markets. Between the
1970s and 2010, metals like aluminum, nickel, tin, steel, cobalt, and molybdenum
would be added.
More than a century later, in 1848, the Chicago Board of Trade (CBOT)
formed, becoming the first official commodity trading exchange in the west. The first
traded futures contract in the U.S. was corn, followed by wheat and soybeans. Several
years later, the first forward contracts in cotton began trading in New York, and other
contracts, including cocoa, orange juice, sugar, cattle and pork futures, soon followed.


11

By the 1970s, the Chicago Mercantile Exchange (CME) started offering futures
trading in foreign currencies and the New York Mercantile Exchange (NYMEX)
began offering various financial futures, including U.S. Treasury bonds and stock
index futures.
Later, in 1874, the CBOT created the Chicago Produce exchange, which was
renamed to the Chicago Butter and Egg Board in 1898. During the First World War,
the exchange suspended activity. Then, in 1919, it was reorganized into the Chicago
Mercantile Exchange, or CME.
The Chicago Mercantile Exchange (CME) solidified its place as the world’s

largest futures exchange in 2008, when CME acquired NYMEX Holdings, Inc., the
parent company of the New York Mercantile Exchange and Commodity Exchange.
We mentioned above that the Chicago Mercantile Exchange started offering futures
trading in foreign currencies starting in 1972 with the founding of the International
Monetary Market. This was just one of several major expansions in futures trading
that occurred in the 1970s. In New York, the New York Mercantile Exchange began
to offer trading in various financial futures, including US Treasury bonds. Eventually,
the NYMEX would offer futures trading in stock market indexes. A division called
the Commodities Exchange also allowed for futures trading in gold, silver, and
copper. Platinum and palladium were added later after the US dollar removed itself
from the gold standard. During this time period, futures contracts became available
on the Dow Jones and S&P 500 stock indexes.
Today, futures trading exchanges can be found all over the world, but America
remains the home of the most active futures trading markets. That’s because two of
the most-heavily traded markets are the US bond market and the wheat market, both
of which have an active worldwide presence.


12

The history of futures trading is as old as civilization itself. It can be traced
back to ancient Babylon and Greece, when merchants exchanged forward contracts.
These merchants all sought the same thing: they wanted to cash in at a fixed price
today to avoid the risk of tomorrow. Futures traders, on the other hand, sought to buy
at a low fixed price today on the assumption that prices would rise in the future.
Over time, we’ve seen the logical progression of futures trading, from
American agricultural futures markets in the Midwest, all the way to the modern
currency trading and financial futures exchanges that started in the 1970s and has
come to dominate the futures markets to this day.

2.2. Stock Index Futures Trading
2.2.1. Index futures trading definition
In the form futures, we have a variety of kind of underlying market such as
commodity, natural resources, financial instrument. Thus, after having general on
futures trading, in this research we just put more attention on the stock index futures
which is really important to comprehend significance of the index futures and it
would be the huge shortage if we just have understanding the futures definition.
In finance, a stock market index futures is a cash-settled futures contract on the value
of a particular stock market index, such as the S&P 500. In the stock index future, the
counterparties agree to trade the underlying index at a certain time for a certain price.
Because it is impossible to physically deliver the index stock market index futures
are settled in cash, especially if the underlying assets are indices. Financial futures
maybe traded like other futures. A security that uses composite stock indexes to
allow investors to speculate on the performance of the entire market, or
to hedge against losses in long or short positions. The settlement of the contracts is
in cash. (Stock Index Future, 2009)


13

Stock index futures are used for hedging, trading, and investments. Index
futures are also used as leading indicators to determine market sentiment. Hedging
using stock index futures could involve hedging against a portfolio of shares or equity
index options. Trading using stock index futures could involve, for instance, volatility
trading (The greater the volatility, the greater the likelihood of profit taking – usually
taking relatively small but regular profits). Investing via the use of stock index futures
could involve exposure to a market or sector without having to actually purchase
shares directly. (David Harper, 2018)
Next, after having a brief about the stock index futures, we want to introduce
its basically contract based on index and its underlying spot market. An index futures

contract states that the holder agrees to purchase an index at a particular price on a
specified date in the future. If on that future date the price of the index is higher than
the agreed-upon price in the contract, the holder has made a profit, and the seller
suffers a loss. If the opposite is true, the holder suffers a loss, and the seller makes a
profit. Futures contracts are legally binding documents specifying the detailed
agreement between the buyer and seller. It differs from an option in that a futures
contract is considered an obligation, while an option is considered a right that may or
may not be exercised. (CME Group, 2013)
A contract for the future delivery of a sum of money based on the value of a
stock index. Unlike other futures contracts, in which a given commodity is specified
for delivery, stock index futures call for cash settlements because it is not possible to
deliver an actual index. This futures contract can be used to speculate on the futures
direction of stock market (rather than just a few stocks) or to hedge a portfolio of
securities against general market movements