Intro to E-Mini Futures

Before we begin discussing our approach to trading, let’s go over some fundamental information surrounding trading and the Futures Market. While it is not imperative to be well versed in all things related to trading, it’s a good idea to review a few things regarding the industry you are preparing to enter.

 

What is a Futures Market?

A futures market is an auction market in which participants buy and sell commodity and futures contracts for delivery on a specified future date. Examples of futures markets are the New York Mercantile Exchange, Kansas City Board of Trade, Chicago Mercantile Exchange and the Chicago Board of Trade.

Originally, such trading was carried on through open yelling and hand signals in a trading pit, like most of us can recall from movie or two. However, in the 21st century, as with the majority of other markets, future exchanges have become primarily electronic.

What is a Future?

Futures are derivative financial contracts that obligate the parties to transact an asset at a predetermined future date and price. Here, the buyer must purchase, or the seller must sell the underlying asset at the set price, regardless of the current market price at the expiration date.

Futures contracts detail the quantity of the underlying asset and are standardized to facilitate trading on a futures exchange. Futures can be used for hedging or trade speculation.

Futures Explained:

Futures (also referred to as futures contracts) allow traders to lock in a price of the underlying asset or commodity. These contracts have expiration dates and set prices that are known up front. Futures are identified by their expiration month. For example, a April gold futures contract expired in April. The term futures tend to represent the overall market. However, there are many types of futures contracts available for trading including:

    • Commodity futures such as in crude oil, natural gas, corn and wheat
    • Stock index futures such as the S&P 500 index
    • Currency futures including those for the euro
    • Precious metal futures for gold and silver
    • U.S. Treasury futures for bonds and other similar products

Pros

    • Investors can use futures contracts to speculate on the direction of the price of an underlying asset
    • Companies can hedge the price of their raw materials or products they sell to protect from adverse price movements
    • Futures contracts may only require a deposit of a fraction of the contract amount with a broker

Cons

    • Investors take on the risk that they may lose more than the initial margin amount since futures use leverage
    • Margin can be a double-edged sword meaning gains are amplified but so too are losses

 

Using Futures:

The futures markets typically use high leverage. Leverage means that the trader is not required to put up the entire contract’s value amount when entering a trade. Instead, the broker would require an initial margin amount, which consists of only a fraction of the total contract value. The amount held by the broker can vary depending on the broker’s terms and conditions.

The exchange where the futures trade will determine if the contract is for physical delivery or if it can be cash-settled. A corporation may enter a physical delivery contract to lock in (hedge) the price of a commodity they need for production. However, most futures contracts are from traders who are only speculating on the trade. These contracts are closed out and are cash-settled.  All the trading we do is cash-settled so there will not be shipping containers of goods arriving on your doorstep.

Futures Speculation:

A futures contract allows a trader to speculate on the direction of movement of a commodity’s price.

If a trader bought a futures contract and the price of the commodity rose and was trading above the original contract price at expiration, then they would have a profit. Before expiration, the buy trade (long position) would be offset with a sell trade for the same amount at the current price effectively closing the long position. The difference between the prices of the two contracts would be cash-settled in the investor’s brokerage account, and no physical product will change hands. However, the trader could also lose if the commodity’s price was lower than the purchase price specified in the futures contract.

Speculators can also take a short or sell speculative position if they predict the price of the underlying asset will fall. If the price does decline, the trader will take an offsetting position to close the contract. A trader would realize a gain if the underlying asset’s price was below the contract price and a loss if the current price was above the contract price.

It’s important to note that margin trading allows for a much larger position than the amount held by the brokerage account. As a result, margin investing can amplify gains, but it can also magnify losses. Imagine a trader who has a $5,000 broker account balance and is in a trade for a $50,000 position in wheat. Should the price of wheat move against their trade, they can incur losses that far exceed the account’s $5,000 initial margin amount. In this case, the broker would make a margin call requiring additional funds to be deposited to cover the market losses.

Futures Hedging:

The type of trading we engage in is known as speculating, however, futures can also be used to hedge the price movement of the underlying asset. The goal here is to prevent losses from potentially unfavorable price changes rather than to speculate. Many companies that enter hedges are using (or in many cases producing) the underlying asset.

For example, a corn farmer can use futures to lock in a specific price for selling their corn crop. By doing so, they reduce their risk and guarantee they will receive the fixed price. If the price of corn decreased, the company would have a gain on the hedge to offset losses from selling the corn at the market. With such a gain and loss offsetting each other, the hedging effectively locks in an acceptable market price.

 

What is the E-Mini?

E-minis are electronically traded futures contracts trading on the Chicago Mercantile Exchange that represent a fraction of the value of a corresponding standard futures contract.

E-mini contracts are available on a wide range of indexes such as the Nasdaq 100, S&P 500, and Russell 2000, as well as commodities such as gold and currencies such as the pound.

Breaking down the E-Mini S&P 500:

All futures contracts have a minimum price fluctuation. This minimum movement is called a “tick.” The value for each tick is always the same because it’s defined by the exchange. In the case of the E-mini S&P 500, the CME (Chicago Mercantile Exchange) has structured the E-mini S&P 500 so that each tick is worth $12.50. Each market (aka “contract instrument”) can have a different tick value. The CME has decided that each index point (“contract unit”) of the E-mini S&P 500 is worth $50. They also decided that four ticks equal one index point. That’s how you arrive at the $12.50 per tick and the market’s tick size of 0.25. Further, $50 (contract unit) * 0.25 (tick size) = $12.50

Here is another example using Crude Oil. The tick size is 0.01. The contract unit is 1,000 barrels. Therefore, 1,000 (contract unit) * 0.01 (tick size) = $10 tick value.

Why does the E-mini use $50 per index point and the Crude Oil use 1,000 barrels? That is decided by the exchange. In defining these values, the exchange considers the “size of the financial instrument” and the “requirements of the marketplace.” The goal of the tick size is to provide traders, investors, corporations, etc. with optimal liquidity and tight bid-ask spreads.

All futures are financial contracts obligating the buyer to purchase an asset or the seller to sell an asset, such as a physical commodity, at a predetermined future date and price. Futures contracts detail the quality and quantity of the underlying asset; they are standardized to facilitate trading on a futures exchange. Some futures contracts may call for physical delivery of the asset, while others are settled in cash. Our transactions are settled in cash.

The value of the full-sized S&P 500 contract had become too large for many smaller traders so the first E-mini contract (the E-mini S&P 500) began trading in 1997. The contract value was one-fifth that of the full-sized contract. A much more recent development occurred in 2019 when the E-micro futures was released. The E-micro offers contracts at one-tenth the size of a classic contract making it even more affordable to get some skin in the game.

Because E-minis and E-micros offer round-the-clock trading, low margin rates, volatility, liquidity, and greater affordability, they are ideal trading instruments for active traders.

 

E-minis/E-micros vs. Full-Sized Futures

There is nothing a full-sized contract can do that the minis and micros are unable to do. All are valuable tools traders and investors use for speculating and hedging. The only difference between them is that smaller players can participate in the E-minis and E-micros.

Money can be made in both directions: Long and Short

The Long and Short are two parties involved in a futures contract.  The two parties are known as the “long” and the “short”.  The long buys the underlying asset while the short sells the underlying asset.

Long and Short in Cash Settled Futures Contracts:

When you are the Long in a cash-delivered futures contract, there is no obligation to purchase the underlying asset and all you are doing is betting on the price of the underlying asset going upwards, just like being long a stock. Conversely, when you are the Short in a cash-delivered futures contract, all you are doing is betting that the price of the underlying asset is going downwards. The underlying asset does not exchange hands at all.

 

What is a Stop?

A stop order is an order to buy or sell a futures contract when its price moves past a certain point, limiting the trader’s loss. Once the price crosses the predefined entry/exit point, the stop order becomes a market order (meaning it is sent to the exchange to be executed).

A stop order is often referred to simply as a “stop.”

 

What is a Profit Target?

A profit target is essentially the opposite of a stop order.  It is a predetermined point at which a trader will exit a trade that is in a profitable position. Profit targets are part of many trading strategies that investors and technical traders use to manage risk.

A profit target is commonly referred to simply as a “target.”

 

How this all comes together?

Here at DTA, you will begin learning how to trade on the E-mini S&P 500. Later, after you develop consistency and we feel that you are ready to trade a live cash account, you will begin with an E-micro contract and scale up from there.  This allows for a more comfortable transition first from a simulated environment, then to a small amount of risk on the micros, and later on to the E-mini.