S&P 500 Futures – What Are The Basics?
S&P 500 Futures are a type of derivative contract that gives a trader a purchase price based on the hope of the S&P 500 Index’s future value. S&P 500 Futures are faithfully followed by all types of traders and the market media as an indicator of market movements. Investors are able to use the S&P 500 Futures to speculate on the future value of the S&P 500 by buying or selling futures contracts.
The S&P 500 Index opens for trading at 9:30 am EST daily and closes at 4:00 pm EST daily. S&P 500 Futures, unlike the index, are open for trade 24 hours a day around the world.
Because S&P Futures trade 24 hours a day, knowing as much as you can about S&P 500 Futures will help you to better hedge or speculate on the potential future value of the multiple components of the S&P 500 Index market.
Investors have two choices when looking for S&P 500 Futures. The Chicago Mercantile Exchange (CME) offers an S&P 500 Futures contract known as the ‘big contract’ with a ticker symbol of SP. It also offers an E-mini contract with a ticker symbol of ES.
Intro to S&P 500 Futures
The CME announced the first S&P 500 Futures contracts in 1982. The CME added the E-mini option in 1997.
The SP contract is the base market contract for S&P 500 Futures trading. It is priced by multiplying the S&P 500’s value by $250. For instance, if the S&P 500 is at a level of 2,500, then the market value of a futures contract is 2,500 x $250, or $625,000.
E-mini Futures were introduced to allow for smaller investments by a broader range of traders. The S&P 500 E-mini Futures are one-fifth of the value of the big contract. If the S&P 500 level is 2,500, then the market value of a futures contract is 2,500 x $50, or $125,000.
The ‘E’ in E-mini stands for electronic. Many traders prefer the S&P 500 E-mini ES over the SP, not only for its lower investment size but also because of its liquidity. Like its name, the E-mini ES trades electronically, which can be more productive than the open outcry pit trading for the SP.
As with all futures, traders are only required to advance a percentage of the contract value to take a position. This represents the margin on the futures contract. These margins are not the same as margins for stock trading. Futures margins show ‘money on the line’, which must be offset or settled.
How Do Futures Work?
Futures contracts allow for securing a targeted price and protecting against the chance of outrageous price swings (up or down) in the future. To explain how futures work, think of jet fuel:
A commercial airline company hoping to lock in jet fuel prices to prevent a sudden increase could buy a futures contract agreeing to buy a set amount of jet fuel in the future at a set price.
A fuel supplier may sell a futures contract to ensure it has a constant market for fuel and to protect against an unplanned slump in prices.
All parties agree on certain terms: to buy (or sell) one million gallons of fuel, supplying it in 90 days, at a price of $3 per gallon.
In this example, the two parties are hedgers, real companies that would need to trade the underlying commodity because it’s the basis of their business. They utilise the futures market to manage their being exposed to the risk of price changes.
But not everybody in the futures market wants to trade a product in the future. These people are investors or speculators, who try to make a profit off price shifts in the contract itself.
If the price of jet fuel rises, the futures contract becomes more valuable as well, and the owner of that contract can sell it for more in the futures market. This type of trader can buy and sell the futures contract, with no intent on taking delivery of the actual commodity; they’re just in the market to bet on price movements.
With speculators, investors, hedgers and others buying and selling daily, there is a vibrant and relatively liquid market for these contracts.
Who Uses S&P 500 Futures and Why?
Day traders, swing traders, hedgers, and hedge funds all trade E-mini S&P 500 Futures. The liquid market enables all these traders to attain and exit positions without any hassle and in volumes that suit each class of trader.
Trades are normally taken for speculative reasons, predicting the future direction of the basket of 500 stocks. Buy a future and, if the value rises, you collect a profit. Sell a future and, if the value drops, you can, likewise, profit. This means traders can profit from either up or down markets.
Hedgers or hedge funds can also use any of the S&P contracts to hedge other positions. For instance, if a trader owns a wide range of stocks, the traders may sell some E-mini S&P 500 or S&P 500 Futures to hedge the long positions. This way, if the index falls (and likely many of the stocks in the trader’s portfolio as well), the loss will be partially or fully balanced out by the gain attained by the short futures position.
Institutional traders can make use of the E-mini S&P MidCap 400 or E-mini S&P SmallCap 600 for the same reasons as mentioned earlier, along with providing funds with more precise exposure to a certain segment of the economy.
The Commitment of Traders Report (here) tracks futures position data for commercial traders, speculators and large traders. The information is openly available, so all traders can see on which side of the market commercial, large and speculative positions are being taken. Although this may not always clarify why traders are doing what they are doing, it does indicate what major market players are doing in the market.
Trading Long (Buy) and Short (Sell)
In the futures market, we can easily trade and turn a profit when the market is going up or going down. When compared with some markets and many individual stocks, the flexibility we have to trade in whichever direction with futures is a major benefit. We don’t need any specific account permissions from our broker or the bare minimum of account sizes to sell to the market, as there is really no useful difference in the futures market between going long and short.
Trade Long or Trade Short
Just in case the terms long and short are new to you, let’s quickly explain them here. When a day trader enters a long trade, they are buying a contract in anticipation of the price going up so they can exit at a higher price for a bigger return. Many investors will use the terms ‘buy’ and ‘long’ interchangeably.
Having said that, when an investor takes a short trade, they are selling a contract with the anticipation that the price will go down. So how does a trader see profits on a contract they do not currently own when the price drops and the contract becomes less valuable?
When short selling, you are basically ‘borrowing’ a futures contract you don’t own from a broker with the intent to buy it later (‘covering’), essentially returning the contract to the broker you ‘borrowed’ from. Doing so allows you to profit from the difference between the initial short price where you borrowed the contract and the cheaper price where you eventually bought the contract. You return the contract to the broker at the initial borrowing price and get a return from the difference in the sale.
Even though it’s useful to grasp the difference between buying or selling a contract, it’s immensely important to realise that in the futures market it makes little difference in terms of your experience as a day trader. During the course of actual trading, both trade types act in a similar way when executed, and there is no difference between them in trading costs.
What Exactly Are Micro E-mini Stock Index Futures?
Micro E-mini Futures are a smaller version of the ordinary E-mini index derivatives for the following US stock indices: S&P 500, Dow Jones Industrial Average, Nasdaq 100, and Russell 2000.
The futures contract for each market gives the investor leveraged exposure to the inherent ‘cash’ stock index that the futures are correlated with. In other words, these derivatives are just like trading a miniaturised version of an entire index in one contract.
These are ‘cash-settled’ instruments. So, if you permit your contract to expire, say, for a purchased (or ‘long’) position, what you get for delivery are not shares of stock but its cash equivalence based on its market value at the time of expiration.
E-Mini S&P 500 Margins
Day traders have lower margin requirements than traders who hold futures positions overnight. A margin requirement is how much the investor must have in their account to open a futures position. For every ES contract held overnight, the investor must have $4,950 in their account when the position is opened.
Day traders do not hold positions overnight and are, for this reason, not subject to this rule. Instead, the broker sets the margin requirement. Day trading margins start at as little as $500 with many brokers. In other words, to open a one-contract position, the investor only needs $500 in their account. Nevertheless, it’s strongly suggested that traders start with a minimum of $3,500 in their accounts.
Contract Specs
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