Movement of the Index

While the NYSE Composite Index reflects the broad market of U.S. stocks, its construction as a capitalization-weighted index means the Index will move similarly to more narrowly-based indexes like the Dow Jones Industrial Average (DJIA) or the S&P 500 Index. For example, the correlation between the NYSE Composite Index and the DJIA has been .98 from August 1 990 through August 1 992. Chart 2 shows the relative performance of these three indexes since September 1 990.

Not only will the NYSE Composite Index move similarly to the DJIA, it will do so in certain ratios, reflecting the prices of the stocks underlying each index. For instance, at each step in an economic cycle, stock sectors react differently, some moving faster than others as the economy accelerates or decelerates.

The ratios tend to change somewhat over time, albeit slowly, as the second tier stocks in the NYSE Composite Index Over-or under- perform the more highly-capitalized stocks in both the NYSE Composite and DJIA. Chart 3 labeled "DJIA to NYSE Composite Index Ratio" describes the movement in the Dow Jones Industrial Average for every full point movement in the NYSE Composite Index. As of December 1991, the ratio was approximately 14:1. That means the DJIA was moving 14 points for every one point move in the NYSE Composite Index.

Many newspapers carry futures prices in a tubular format. In Table I at right, the NYSE Composite Index futures daily price activity is shown for the previous day. Among the prices listed in the table are the daily open, high, low and close and net change for the day. Also included are the lifetime high and low for the expiration cycle of that contract (based from its first trading day) as well as the open interest, or number of contracts outstanding for each expiration month. Volume is estimated for the current day's activity and the previous day's trading volume (or cleared volume) is the number of contracts traded and cleared.

The table also includes the NYSE Composite cash Index high, low, close and net change for the day. The cash Index is calculated and disseminated every 1 5 seconds throughout the trading day.

Using NYSE Composite index Futures

With the advent of stock index futures in 1982, stock market participants for the first time had a direct means with which to buy or sell "the stock market" as a single entity. Since that time, traders or hedgers with a view on market direction have actively bought and sold the market itself, as represented by the NYSE Composite Index, in a single decision.

One of the key features of stock index futures is their ability to separate components of stock portfolio risk into two categories stock specific risk unsystematic risk and broad market risk (systematic risk. Unsystematic risk can be hedged through portfolio diversification, while systematic risk can be hedged with stock index futures. The popularity of stock index futures can be attributed, in part, to this ability to hedge the systematic risk of equity portfolios.

Trading the Stock Market with NYSE Composite Index Futures

A trader or a long hedger expecting rising stock prices could buy a futures contract on the NYSE Composite Index. If the market price does turn up, the buyer will gain from the daily increase in the price of the NYSE Composite Index futures contract.

In Example One, a bullish move is reflected in an increase of 5.50 points, from 223.20 to 228.70. When the long NYSE Composite Index futures position is closed out on October 30, the bullish position has a profit of $2,750 @5.50 x $500), less commissions. Conversely, a decline of 5.50 would have resulted in a loss of $2,750, not including commissions, brokerage fees or transaction charges.

In this case, the trader would have earned a profit for his assumption of risk. The long hedger who bought rising stock index futures in advance of anticipated stock purchases would apply the gain in the futures position toward actual stock

Bear markets also offer profit opportunities. A trader or a short hedger anticipating lower stock prices could sell a NYSE Composite Index futures contract short. A possible selling strategy is shown in Example Two. Here, the NYSE Composite Index futures declined from 226.40 to 21 9.2U. I hat decline of 7.20 points resulted in a $3600 profit, not including commissions, brokerage fees or transaction charges.

In this case, the trader who sold short would have generated a profit. The short hedger who sold stock index futures to protect a stock portfolio could have achieved some protection for his portfolio in the subsequent market decline.