What are Futures Contracts?
The futures market provides the basis for the Emini day trading we do here at Samurai Trading Academy, so it's probably best to start with a quick summary of what futures are. While many people are familiar with stocks, bonds, or forex, there are quite a few who don't have much direct experience in futures. This is somewhat surprising considering they are among the most actively traded markets in the world.
A futures contract is an agreement between the seller to deliver and for the buyer to take delivery of a commodity at a specified future date. In some cases this is an actual physical commodity but much of the futures trading that occurs is based on stock price indexes like the S&P 500, which means we are buying virtual rights to a certain value in the index that we can then sell to someone later at a different price (hopefully at a profit). In this case the delivery is simply a cash settlement on the difference between the original transaction price and the final price of the index at the termination of the contract.
The price of a futures contract responds to changes in the overall underlying index and the value is recalculated as the stocks that compose the index change in value. So while a futures contract may be priced slightly higher or lower than the index it is based on, it generally does follow it very closely.
The Introduction of the S&P 500 Futures Contract
In 1982 the Chicago Mercantile Exchange (CME) introduced the S&P 500 futures contract and it quickly became the most actively traded market of its time. While the Dow Jones Industrial Average only tracks 30 blue chip stocks, the new S&P 500 Index is based on the market capitalizations of 500 companies in the U.S. stock market over a variety of market sectors. In 2012 the S&P sectors that composed the 500 company index included Technology (19.27%), Financials (15.14%), Health Care (12.21%), Energy (11.31%), Consumer Discretionary (11.05%), Consumer Staples (10.85%), Industrials (9.85%), Utilities (3.60%), Materials (3.55%) and Telecom (3.17%).
This diversity made the S&P 500 index much more representative of the overall market's health and increased its popularity as a premier trading market. By trading S&P 500 Futures you are essentially buying and selling an extremely well diversified portfolio of stocks in a single index futures contract.
Advantages of Trading S&P 500 Futures Vs Individual Stocks
- Only one chart is needed to trade S&P 500 futures. Some people may look at multiple tick sizes or time frames, but these can easily be scrolled through on a single chart. Compare this to trading individual stocks, where you may be looking at 10, 50, or even hundreds of different charts throughout the trading day.
- Liquidity is much higher, which minimizes slippage on trades. Many individual stocks are lightly traded which increases your risk when you can't get filled where you placed your original stop loss order.
- There are no restrictions on going short (selling). You can go long (buy) or short (sell) with the S&P 500 Futures contract at any time. There is also no Alternative Uptick Rule.
- The brokerage commissions for round-trip trading are usually much lower for the S&P 500 Futures contract.
- As the S&P 500 Index is very diversified, it reduces the risk of sudden adverse moves that are not uncommon in trading individual stocks. This combined with the slippage problem mentioned above can make trading individual stocks much riskier.
- You can trade the S&P 500 with very minimal market research, unlike individual stocks which usually require considerable study time for dozens of companies.
The Creation of the Emini S&P 500 (ES) Futures Contract
As the stock market continued to strengthen through the 90's it became increasingly more difficult to trade S&P 500 Futures contracts. The price had simply become too large for many of the smaller traders (then valued at $500 times the index, or over $500,000 at the time). The CME stepped in on September 9th, 1997 to alleviate this problem with the creation of the Emini S&P 500 (ticker symbol ES) futures contract. Emini day trading was born and the ES quickly became the most popular equity index futures contract in the world.
As the Emini S&P 500 is only traded electronically (hence the E in Emini) on the CME Globex Exchange it gave an even playing field to many traders compared to the S&P 500 contract which was traded in an Open Outcry trading pit at the Chicago Board of Trade. The success of the ES futures contract led to the explosion of Emini day trading, as numerous contract variations were later introduced like the Emini NASDAQ 100 and the Emini Russell 2000.
Details of the Emini S&P 500 (ES) Futures Contract
The Emini S&P 500 contract trades 23 hours a day from 5:00 PM CST (the CME is based in the Central time zone) until 4:15 PM CST the next day. Trading is halted between 3:15 PM CST and 3:30 PM CST each day for a maintenance period. It trades five days a week and is on a quarterly expiration cycle.
While the contract does trade for most of the day, here at Samurai Trading Academy we prefer to focus our Emini day trading on what we consider the part of the trading day which offers the highest quality opportunities. Usually this is from approximately 9:30 EST (we use Eastern Standard Time as we start at the New York Stock Exchange open) until 12-1 EST (New York lunch). While there can also be many opportunities during the New York afternoon our Emini day trading approach is to maximize the trading potential in the morning session every day and leave the afternoon session entirely optional. After all, who wants to sit at the screens all day if you don't have to?
Since futures contracts were originally designed as contractual agreements for the delivery of a commodity at a specified time in the future, Emini futures contracts expire as well. Emini S&P 500 (ES) futures contracts expire quarterly on the third Friday of March, June, September and December. For example, an ES contract due to expire in March, 2013 would be listed as ES 03-13. On the third Friday of March, the contract would roll over and we would then trade the new contract for June (ES 06-13) for the next three months.
As Emini day traders this rollover doesn't effect us much as we don't hold positions in the market overnight or during the expiration time, but we need to know about this feature of the futures market so we remember to take a minute to change over our trading contract every few months.
The Value of an ES Contract
Emini day trading is quite different from trading the larger contracts due to the variations in price movement and tick pricing. A full-sized S&P 500 Futures contract moves in minimum increments we call ticks where each has a size of 0.10. There are 10 ticks in every one point of movement you see on the S&P 500 Index. Each tick is worth $25, which means each full point of movement is equal to $250.
The Emini S&P 500 uses different tick and point values that are well suited for novice and veteran day traders alike. Ticks in ES are each 0.25, meaning there are 4 ticks for every one point of movement. Each tick is worth $12.50 in ES, so a full point of movement is equal to $50. So as you can see the Emini S&P is one fifth the size of a full S&P futures contract. For those of us involved in Emini day trading this is a huge advantage.
Conclusion - What Are Emini S&P 500 Futures
You should now have a good understanding of what Emini day trading is and how Emini futures came to be such active markets for traders. Here at Samurai Trading Academy the ES is our preferred market due to the liquidity, volatility, and ease of access but many of our methods can easily be applied to other futures markets as well.
In future articles in this series we plan on covering a number of topics related to Emini day trading. We'll discuss the advantages of day trading Eminis compared to other markets, why ES is a great market for novice traders, and we'll also talk about what you need to be able to start day trading yourself.
Emini Day Trading Series Articles
Part 1: What Are Emini S&P 500 Futures?