Now every day for the U.S. market, people will look at the futures price during the pre-market to gauge whether the stock market will open higher that day, or lower. How that is done is by comparing the futures price with the fair value of the futures.
If the futures prices are higher than the fair value, people expect the market to open higher that day, and conversely if the futures prices are lower than the fair value, people expect the market to open lower.
Some key points
- The futures prices usually displayed are the futures prices for the indices (S&P 500, Nasdaq, Dow) for the front month, i.e. the nearest expiry month.
- The fair values of the futures shown in the pre-market are based on the last closing prices of the stock market indices.
- Fair value of futures = stock market index value (also known as the cash price) * (1 + R * d/360) – dividends
- d is the number of days to the expiration of the contract
- d/360 is the day count convention for the annual interest rate R
- dividends is the dividends paid by the stocks in the index until the expiration of the contract, expressed in points of the index. For example, with a dividend yield of 2%, cash index value of 100, annual dividend in terms of points is 2 points on the index, multiply that with d/360 to get what you need to subtract in the formula above.