One way to get broad exposure to the Australian stock market is through the SPI 200, a stock market index that tracks the fortunes of the largest companies in Australia. This can be an important part of a diversified global stock portfolio. The SPI 200 also has a lively market in futures contracts, as well, explained below.
The SPI 200, or Share Price Futures 200, is the name of a specific type of derivative of a stock market index. An index is a fictional construct that tracks the performance of a group of investments. In the case of the SPI 200, this particular index tracks the price performance of the 200 largest stocks in Australia, as measured by market capitalization. The market name of this index is the ASX 200. Larger stocks have a larger weight in the performance of the index. You cannot invest directly in an index. But many investment companies have built mutual funds by building a portfolio of stocks in an index, weighted by their market capitalization, and sold shares to the public. No one manages these funds. The fund simply buys the companies in the index and does not try to guess which stocks will outperform the market.
A futures contract is a derivative. It is not an investment in a tangible underlying asset. All it is is an agreement to deliver a specific security at a specific price at a predesignated point in time. Someone who is selling an SPI 200 futures contract is agreeing to sell someone a set number of shares in an index fund that tracks the SPI 200 at a specific price at some point in the future.
Purpose of a Futures Contract
Futures contracts have an important role in allowing investors to "hedge" their exposure to a specific investment. Anyone buying or selling a futures contract is hoping to protect themselves against the possibility of a large price swing for a specific amount of time.
In addition to the hedging aspect, some investors seek to profit by speculating in futures, rather than in buying shares of SPI 200 funds themselves. If the SPI 200 moves above the agreed-upon delivery price, the market value of the contract itself will rise -- especially as the delivery date gets closer, since the certainty of payoff increases with time, as well. Investors can purchase a large amount of potential profit for a relatively small amount of capital invested, simply by purchasing a futures contract, rather than the fund itself. However, potential losses are greater, as well.
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