A Dow Jones futures contract is one based on the value of the Dow Jones Industrial Average (DJIA) index rather than an actual physical asset. The net difference between the strike price and the actual value of the index on the expiration date is exchanged for cash when the contract is settled.

Cost of Carry

To determine the cost of the contract, the exchange creating it must calculate the "cost of carry" through its duration. The cost of carry is equal to the cash value of the contract plus the interest the same amount would earn if invested in a euro dollar or Treasury bond at the basic interest rate over a given period.

Premium Price

The premium price is the cash value of the contract plus the cost of carry. This amount can change if any DJIA company pays a dividend during the life of the contract. If this happens the dividend amount is subtracted from the original premium.

DJIA Contract Values

The cash value of a standard ($10 contract) DJIA futures contract is ten times the Dow Index. For example, if the Dow is at 10,000, the value of the contract is $100,000 (10,000 x $10 = $100,000). The interest amount for the premium is calculated based on the $100,000 value. The value of the contract changes by ten dollars for every point change in the DJIA. For example, if the average decreases 20 points, the contract value decreases $200 and vice versa.

Trading on Margin

Margin is a minimum amount that must be paid to control a contract. It is a fraction of the actual price of the contract. Margin amounts can be as small as one percent of the actual price. Using the above example, an investor would need a margin account with $1000 plus the interest amount to control one contract. However, if the DJIA moved even one point in the wrong direction there would be a margin call and the investor would need to put up additional cash to cover the difference in the value of the contract--otherwise, the account would be closed and the investor would owe the money. As a practical matter investors should have extra cash in their margin accounts to cover possible losses.

Positions (Long and Short)

An investor can either purchase a contract, which means he is long, or sell a contract, which means he is short. When an investor is long, the index needs to rise in order to make money; when short, the index needs to decline in order to make money.

Source:

Investopedia: Futures Fundamentals: Introduction

CME Group: Dow Jones Industrial Average

CME Group: Equity Index Home Page

More Information:

Futures 101: Commodity Trading Education and Futures Trading Kits for Investors