Index Futures Contract Expiry

We often talk about the SPI and its relationship to the equity market. The Index futures contracts expiry day (the third Thursday of the expiry months; March, June, September and December) normally lead to extreme volume early in the day as futures contracts are settled.

On the ASX (Australian Securities Exchange), futures contracts are traded over three sharemarket indices, the S&P/ASX50 Index, the S&P/ASX200 Index and the S&P/ASX 200 Property Trusts Index. They are issued with a value of $25 per point, but a mini index at $10 per point is also able to be traded.

Index Futures are cash settled. Settlement is based upon the opening prices of the stocks in the underlying index on the morning of the maturity date. Therefore as each stock in the XJO opened this morning the price was recorded and the index value was calculated, anybody who then held a futures contract had to cash settle at that level (6398). The trader's profit or loss depends on how far the price of the futures contract at maturity is above or below the price at which the contract was initially traded.

Institutional traders use index arbitrage when trading the futures, at anytime before expiry they are taking advantage of any discrepancy in the price relationship between the futures and the physical market. For example, if the futures are overvalued compared to the physical XJO then arbitrage traders will buy the stocks comprising the XJO, whilst simultaneously selling SPI futures contracts and therefore 'locking in' the arbitrage profits. However, the opposite is true, if the Futures are undervalued compared to the physical market then traders will sell the stocks comprising the XJO whilst buying the futures. This morning stocks such as Woodside Petroleum (WPL) were affected by arbitrage positions being closed out, leading to a high opening price, despite a fall in the oil price overnight, as traders had to buy Woodside shares to unwind their arbitrage positions. The WPL price quickly adjusted down after a couple of minutes.

Valuing a contract

The value of a futures contract in theory should approximately equal the current value of the underlying shares or index, plus the 'cost of carry'. The cost of carry is the cost of holding the stocks that comprise the index over the life of the futures contract, less any dividends on those shares during that time.