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Introduction to

E-mini Stock Index Futures

BY JACE JARBOE

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INTRODUCTION TO E-MINI STOCK INDEX FUTURES About the Author Jace Jarboe is a Junior Commodity Broker with Daniels Trading. He is a licensed Series 3 broker with the National Futures Association (NFA). Prior to joining the futures industry, Jace attended Indiana University where he received a Bachelor of Arts degree in Economics. While earning his degree he found a great passion in following and analyzing the different financial markets. Upon discovering the career opportunities at Daniels Trading, Jace soon developed a keen interest in commodities and the unique role of futures. Since then, Jace has been devoted to learning all aspects of the futures industry and is dedicated to helping his clients achieve their short and long term trading goals.

Contact Jace Jarboe 1-312-706-7639 Local 1-855-758-2749 Toll-Free 1-312-706-7539 Fax [email protected]

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INTRODUCTION TO E-MINI STOCK INDEX FUTURES Introduction This guide focuses on E-mini stock index futures. While there are many stock index futures contracts available today, this analysis will only consider the most frequently traded indices in the US markets. This includes the E-mini futures that are derived from the S&P 500, Dow Jones Industrial Average, and the NASDAQ Composite.

Goals and Takeaways The goals of this report is to define: • The reasons why these types of futures are traded • What exactly they are and how they work • How to properly trade stock index futures The takeaways from this report are: • The benefits of trading index futures • The contract specifications • The various ways they are used to trade with one’s already existing stock or commodity trading account

History E-mini futures were first launched in 1997 with the E-mini S&P 500 (ES) contract. The main reason was because the actual S&P 500 index became too large for most traders. The ES quickly became appealing to the everyday investor due to its smaller contract value and around-the clock availability on the CME’s Globex trading system. These qualities have created excellent liquidity in the markets of index futures. Shortly after the birth of the ES, many other E-mini futures were pioneered as well. Like the ES, the E-mini DJIA $5 (YM) and E-mini NASDAQ 100 (NQ) are also very popular markets today. Stock index futures closely follow the price movement of their respective indices. For this reason, many traders find the E-mini futures markets relevant and useful to minimize risk as well as diversify with their open stock positions.

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INTRODUCTION TO E-MINI STOCK INDEX FUTURES Advantages E-minis offer great advantages to traders today and that is the reason they have been among the fastest growing products at the CME in the past 20 years. The total volume has grown so high in recent years that they are now some of the most liquid markets in futures today. The open interest in these markets has expanded due to their tight bid-ask spreads, which only increase the liquidity. Seeing these bid-ask spreads offers transparency for traders. Since the E-mini stock futures are traded entirely online, they offer a fast and easy way to execute trades in the most important markets in the world today. They are also open a total of 23 hours a day during the week, making them convenient for the typical retail trader. This creates accessibility around the world.

Hedging/Speculating Techniques Furthermore, futures are commonly paired with terms such as hedging and speculating. With stock index futures, hedging strategies can still be enabled. Many traders decide to turn to futures to manage risk against their open stock positions. For example, if a trader is worried about their current long position in Apple (AAPL) they might consider shorting a number of contracts of the mini Dow or mini NASDAQ to hedge. This type of hedging technique can be applied for any investor who owns shares in companies that are included in the S&P 500, Dow Jones Industrial Average, or NASDAQ Composite.

Shorting Futures allow traders to enter short positions just as easy as it is to enter long positions. Unlike stocks, there is no uptick rule for you to enter a short position. Futures contracts have contract limits set by the exchanges but there is no different requirement between going long or short like with stocks. Shorting index futures allows investors to take advantage of the stock market when they expect a downtrend or bearish duration.

Benefits In addition to the benefits already mentioned, some investors could turn to futures instead of stocks because of the leverage that is offered. Futures only require initial margin for each contract bought or sold. Margining in stock index futures only requires 5-20% of the contract value. E-mini index futures can be very attractive to day traders because they typically have the lowest day trading margins.

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INTRODUCTION TO E-MINI STOCK INDEX FUTURES For example, current exchange minimum margin requirements for the ES, YM, and NQ futures are all just $500 (see table below - click for a list of margin requirements).

One does not require the high value amount of the full-size contract but instead can put up the initial margin amount, which enables traders to have multiple positions at a time. This aspect can greatly amplify gains as well as losses. Lower margins make these products more affordable to investors. Additionally, index futures can be a cheaper alternative to stocks because of their potentially lower trading costs. Another way to participate in the upward or downward movements in the equity markets is by buying or selling index contracts. This position will offer exposure to all securities included in that particular index.

Mini Contracts There are many E-mini futures contracts available today, as well as even smaller E-micro contracts. These types of contracts are not only offered in index futures and currencies such as the E-mini Euro FX, but they are also traded in terms of physical commodities. Today, there are mini contracts of crude oil, corn, gold, and many others. These smaller contracts offer the ability for more traders to take action in the commodity markets. E-mini contracts are usually ½ or 1/5 the size of their full contract counterparts which allow smaller investors to participate in trading futures. In addition, E-mini index contracts offer weekly options. These options provide further risk management techniques due to their short time frame and much smaller premium amounts.

ES, YM, and NQ The ES, YM, and NQ have really started the upward trend in trading mini contracts. The purpose of these three products is to offer an accessible and feasible alternative to managing risk in the US stock market or to speculate on an entire index. For the most part, these three indices are very similar in how they function and how they are traded, but there are some technical differences.

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INTRODUCTION TO E-MINI STOCK INDEX FUTURES E-mini S&P 500 The ES is used to offer exposure to the 500 individual stocks that make up the underlying Standard & Poor’s 500 index. The total price of the S&P 500 index is the current index value multiplied by 250. The ES is only one-fifth of the size of the actual index. Its total price is calculated by taking the current index futures value multiplied by 50. Total Contract Value = 2,156.75 * 50 = 107,837.50 The ES has a tick size of 0.25. Where each tick is worth $12.50 and each point is worth $50.00. The contract margins for the ES are as follows: Margin Requirements (ES) Day Trading

$500

Overnight

$5,060

Maintenance

$4,600

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INTRODUCTION TO E-MINI STOCK INDEX FUTURES E-mini DJIA The YM offers exposure to 30 US blue-chip stocks that make up the DJIA index. The total price of the Dow index is the current index value multiplied by $10. The YM is half the size of the actual Dow index. Its total price is calculated by taking the current index futures value multiplied by $5.00. Total Contract Value = 18,190 * 5 = 90,950 The YM has a tick size of 1 so each point is worth $5.00 as well. The contract margins for the YM are as follows: Margin Requirements (YM) Day Trading $500 Overnight $4,290 Maintenance $3,900

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INTRODUCTION TO E-MINI STOCK INDEX FUTURES E-mini NASDAQ 100 The NQ is also used to offer exposure to all of the underlying securities listed on the NASDAQ stock exchange. The NQ’s total price is calculated by taking the current index futures value multiplied by $20.00. Total Contract Value = 4,870.25 * 20 = 97,405 The NQ has a tick size of 0.25. Where each tick is worth $5.00 and each point is worth $20.00. The contract margins for the NQ are as follows: Margin Requirements (NQ) Day Trading $500 Overnight $3,960 Maintenance $3,600

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INTRODUCTION TO E-MINI STOCK INDEX FUTURES Contract Details All three of these index futures are cash settled, unlike their index counterparts which are settled by the underlying shares in their respected companies. In commodities, cash settlement means that at the end of the contract, the holder of the position is simply debited or credited the difference between their entry price and the final settlement price. They all have the same four contract months which are as follows: • March (H) • June (M)

• September (U) • December (Z)

Hours As previously mentioned, one of the best qualities about E-mini index futures are their nearly 24-hour market. For these three contracts, market hours are Sunday to Friday from 5:00 PM CST – 4:00 PM CST with a 15-minute trading halt from 3:15 PM – 3:30 PM. These Globex hours have turned index futures into some of the most liquid markets around due to their convenient trading times.

Who Trades them? E-mini index futures can be utilized by all different types of investors, whether institutional or retail. Financial institutions, managed funds, high-frequency trading firms, and individual traders are all largely active in trading these types of futures. Portfolio managers and other industry professionals use the stock index futures to manage risk and hedge against adverse price movements for their portfolios. Examples of this are: when earnings are released, a negative company headline, the VIX increases, FOMC press conference, etc. Other traders, whether day trading or swing trading, utilize the E-minis to speculate on price fluctuations in the stock market. Both types can gain or lose in these markets through its price transparency enabled by online trading.

Fundamental vs. Technical Analysis E-mini index futures do not follow a single stock, but are based off of numerous stocks that make up that particular index. For this reason, E-mini traders typically do not rely on a company’s press release or earnings report. Fundamental news can still be the main driving force and major component for market movement but

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INTRODUCTION TO E-MINI STOCK INDEX FUTURES it sometimes feels as if it takes a back seat to technical trading in these markets. E-mini traders frequently use technical information when making decisions. Technical analysis is a dominating force in the E-mini trading space. Technical analysis allows E-mini traders to evaluate past performances and attempt to predict future price movements. Although this is true, fundamentals and geopolitical news can trump technical setups, so they should not be ignored in your trading analysis.

Technical Indicators Technical traders make up the majority of the E-mini index markets. An important element to the modern screen trader are the indicators they equip themselves with to analyze and execute trades. They are best utilized by using charts that show price movements and developed indicators. Daniels Trading offers dt Pro, our own platform that comes with numerous indicators to complement your trading. Examples include moving averages, trend followers, volumes, oscillators, and other 3rd-party indicators that can be applied to our platform. These types of additions are important to have so that any trader may receive that critical edge when trading in the E-mini index markets.

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INTRODUCTION TO E-MINI STOCK INDEX FUTURES Correlations As already mentioned, E-mini index futures are highly correlated with the US stock market. The ES, YM, and NQ are also correlated with one another. These indices are highly correlated so they usually move directionally with one another, creating short periods of arbitrage-like opportunities. When one of these indices is positive, they are most likely all positive. When one of these indices is trending lower, then they are most likely all having bearish movements. For this reason, many experienced traders look for divergences between these three contracts. By analyzing these markets simultaneously, one can determine which index is leading for that day (or lagging behind) and make a trade on this discrepancy between the correlated indices. Like the divergences in these markets, the convergences also can help traders make trade decisions by receiving confirmation from the price direction of related E-mini index contracts. Since they are so closely correlated, some traders monitor all of these index futures while they only actually trade one of them. By doing this, the trader can confirm the direction the contract will be moving when compared to the other indexes. This gives a trader some additional affirmation on their trade ideas and offers them extra confidence in these markets.

Wrap-up In this guide, we summarized and highlighted the important details in the E-mini stock index futures markets. After reading this guide completely, a trader should be able to state: • What equity index futures are • Why people choose to trade them • How they are best utilized • What their contract specifications are The main takeaways in this guide are knowing: • All of the great benefits that these futures contracts offer • The different ways they can be implemented to either hedge or speculate in the US markets

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INTRODUCTION TO E-MINI STOCK INDEX FUTURES I encourage anyone who is an active online futures trader, current stock trader, or someone who is interested in learning more about these exciting markets to please contact me for additional details or visit the Daniels Trading website. I am happy to go into further depth in explaining these markets and helping anyone develop a trading plan.

Additional Resources DT PRO Demo Request Get the professional futures trading sofware designed for active traders. dt Pro is an easy to use application that handles all of the complexities associated with trading and order management. Experience our premier online commodity trading platform with a free 2-week trial. https://www.danielstrading.com/offer/dt-pro-futures-trading-software-demo

Futures Calculator Use our dt Futures Calculator to quickly establish your potential profit or loss on a futures trade. This easy-to-use tool can be used to help you figure out what you could potentially make or lose on a trade or determine where to place a protective stop-loss order/limit order to capture your profit. https://www.danielstrading.com/trading-resources/futures-calculator

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INTRODUCTION TO E-MINI STOCK INDEX FUTURES DISCLAIMER THIS MATERIAL IS CONVEYED AS A SOLICITATION FOR ENTERING INTO A DERIVATIVES TRANSACTION. THIS MATERIAL HAS BEEN PREPARED BY A DANIELS TRADING BROKER WHO PROVIDES RESEARCH MARKET COMMENTARY AND TRADE RECOMMENDATIONS AS PART OF HIS OR HER SOLICITATION FOR ACCOUNTS AND SOLICITATION FOR TRADES; HOWEVER, DANIELS TRADING DOES NOT MAINTAIN A RESEARCH DEPARTMENT AS DEFINED IN CFTC RULE 1.71. DANIELS TRADING, ITS PRINCIPALS, BROKERS AND EMPLOYEES MAY TRADE IN DERIVATIVES FOR THEIR OWN ACCOUNTS OR FOR THE ACCOUNTS OF OTHERS. DUE TO VARIOUS FACTORS (SUCH AS RISK TOLERANCE, MARGIN REQUIREMENTS, TRADING OBJECTIVES, SHORT TERM VS. LONG TERM STRATEGIES, TECHNICAL VS. FUNDAMENTAL MARKET ANALYSIS, AND OTHER FACTORS) SUCH TRADING MAY RESULT IN THE INITIATION OR LIQUIDATION OF POSITIONS THAT ARE DIFFERENT FROM OR CONTRARY TO THE OPINIONS AND RECOMMENDATIONS CONTAINED THEREIN. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE. THE RISK OF LOSS IN TRADING FUTURES CONTRACTS OR COMMODITY OPTIONS CAN BE SUBSTANTIAL, AND THEREFORE INVESTORS SHOULD UNDERSTAND THE RISKS INVOLVED IN TAKING LEVERAGED POSITIONS AND MUST ASSUME RESPONSIBILITY FOR THE RISKS ASSOCIATED WITH SUCH INVESTMENTS AND FOR THEIR RESULTS. YOU SHOULD CAREFULLY CONSIDER WHETHER SUCH TRADING IS SUITABLE FOR YOU IN LIGHT OF YOUR CIRCUMSTANCES AND FINANCIAL RESOURCES. YOU SHOULD READ THE “RISK DISCLOSURE” WEBPAGE ACCESSED AT WWW.DANIELSTRADING.COM AT THE BOTTOM OF THE HOMEPAGE. DANIELS TRADING IS NOT AFFILIATED WITH NOR DOES IT ENDORSE ANY TRADING SYSTEM, NEWSLETTER OR OTHER SIMILAR SERVICE. DANIELS TRADING DOES NOT GUARANTEE OR VERIFY ANY PERFORMANCE CLAIMS MADE BY SUCH SYSTEMS OR SERVICES.

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