Chapter 29: Introduction to Index Option Products and Futures 507 
let us look at a simple example of how one might hedge a stock portfolio with stock 
index futures. 
Example: Suppose that a stock mutual fund operates under the philosophy that 
investors cannot outperform a bullish market, so the best investment strategy when 
one is bullish is just to "buy the market." That is, this mutual fund actually buys all 
the stocks in the Standard & Poor's 500 Index and holds them. 
If the manager of this fund turns bearish, he would want to sell out his positions. 
However, the commission costs for liquidating the entire portfolio would be large. 
Also, the act of selling so much stock might actually depress the market, thereby 
devaluing the remainder of his portfolio before he can sell it. 
This manager might sell S&P 500 futures against his portfolio instead of selling 
his stocks. Such a futures contract would move up or down in line with the S&P 500 
Index as it rises or falls. Suppose that he sold enough futures to hedge the entire dol­
lar value of his stock portfolio. Then, even if the stock market declined, his futures 
contracts would decline also and would theoretically prevent him from having a loss. 
Of course, he couldn't make much of a gain if the market went up, since the futures 
would then lose money. What this money manager has accomplished is that he has 
effectively sold his stock portfolio without incurring stock commission costs (futures 
commissions are normally quite small). 
If he turns bullish again at some later date, he can buy the futures back, and 
have his long stocks free to profit if the market rises. Again, he does not spend the 
stock commission nor does he have to go through the tedious process of placing 500 
stock orders to "buy" the S&P 500 - he merely places one order in futures contracts. 
Futures contracts often trade at premiums to the underlying commodity, due to 
the fact that the investor who buys the future does not have to spend the money that 
one who buys all the stocks would have to spend. Thus, he saves the carrying costs 
but forsakes any dividends. This savings is reflected by the marketplace in that a pre­
mium is placed on the price of the futures contract. As a consequence, longer-term 
contracts trade at a larger premium than do near-term contracts, much as is the case 
with options. In most cases, however, the index futures trader is concerned with the 
nearest-term contract, and perhaps the next one out in time. 
TERMS OF THE CONTRACT 
There are cash-based index futures on several indices, although some of these futures 
contracts are not heavily traded. The most heavily traded contract is the future on the 
S&P 500 Index. This contract trades on the Chicago Mercantile Exchange. It has con­
tracts that expire every 3 months (March, June, September, December) and a 1-point