The significance of futures contracts

Technology is the key player in the development of new markets. Although futures contracts ... have been around for years, selling stock indexes and futures contracts on stock indexes are a relatively new phenomenon. These new markets were created because the speed of transactions was icreased[sic] to near instantly. Without computers, index arbitraging would be impossible. (citation)

In the last 15 years, the stock index futures market has developed into one of the most important tools for money manager to master. Proper manipulation of index futures, in the form of portfolio insurance, can mean the difference between keeping a fund secure and exposing it to the full risk of the volatile stock market. As the market becomes riskier and as expectations drop, managers increasingly sell futures contracts. This reduces their chance of making a good return on the investment, but insures that the core value will be retained. Increasingly, the futures market broadcasts the expectations of investment professionals.

Given its importance to institutional investors who, in 1983 initiated 90% of all trades (citation) and its role in defining New York's expectations on where the Stock Market is moving, it's no surprise that the futures market played a vital role in the 1987 crash. Friday, October 16, was the worst trading day in exchange history to date. With an entire weekend to build up anxiety, institutions placed huge sell orders on the futures market Black Monday morning. The price of index futures plummetted, at times to an unheard of 15 to 20 percent less than they should have been relative to the price of the underlying index. This provided huge opportunity for index arbitration programs, which were churning out buy orders on the futures market and sales orders on the stock exchange. Thus, computer power enabled poor expectations on the futures market to instantaneously become strong downward pressure in the stock exchange.