Index futures

Index futures are a contract for difference on the level of an index. They may be used speculatively or to hedge non-diversifiable risk.

The most important use of index futures, to most investors, is to hedge beta, the element of risk that cannot be diversified away. The end result of fully hedging beta on a well diversified portfolio would be the construction of a portfolio that is riskless. The law of one price implies that this should return the risk free rate. This may seem pointless, but there are a number of reasons for doing this:

On the other side of the futures, they are a way of buying the index on margin (i.e. increasing beta rather than decreasing it), together with the other reasons above.

Index futures on major markets are widely used. As a result, a wide choice of contracts (expiry dates and prices) are available and they are usually liquid.

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