Part of being a trader is evolving not only as the market changes, but as you change and learn new information and assimilate that information into what you already know.
I’ve shied away from trading futures heavily, because of a lack of experience or comfort with that market, compared to my years of knowledge about the stock market.
However, the futures market offers certain benefits within stark similarities that no stock or no ETF can offer, and so I’ve been increasing my index futures trading recently, and wanted to share what I’ve learned so far.
I suspect a majority of traders who trade index futures trade the S&P 500, or e-Mini (@ES) contract. I don’t. I don’t like or understand the price structure yet on the contract. I also do not trade the @NQ (Nasdaq mini) for the same reason. Perhaps I’ll shift in the future, but what makes sense to me logically and price structurally is the Dow-Mini (@YM).
Let’s look at these:
The S&P 500 ‘e-mini’ (@ES) contract trades in quarter-point increments, where each ‘tick’ is worth $12.50 per contract. A full S&P point is worth $50.
The Nasdaq 100 ‘e-mini’ (@NQ) contract also trades in quarter-point increments, where each ‘tick’ is worth $5.00. A full ‘Nasdaq” point is worth $20.
The Dow 30 ‘e-mini’ (@YM) contract trades in single-point increments, where each ‘tick’ is worth $5. A full Dow Point is worth $5. Ten Dow points are worth $50.
Of course, there are other contracts, including a full Dow contract ($25 per point/tick) and other S&P/NASDAQ contracts, but we will stick with discussing the ‘minis’ here.
To me and I speak only for myself the Dow pricing structure makes sense most intuitively for me. Hence, I am building experience and familiarity first with the Dow and then to other contracts. It’s easier to me to calculate intuitively the value of a position when it’s “in terms of the Dow futures.” For the rest of the article, I will speak in terms of “Dow e-Mini Futures” but realize that what I say applies to the other Index Futures contracts as well
The first benefit is that futures trade 23 hours per day. It’s not fair to assume that the volume, interest, chart patterns, and indicators WORK 24-hours a day because they don’t. The patterns and price action are most robust during normal market hours and slightly beyond. However, if something major happened after the stock market has closed, you can offset or add to your existing futures position whenever you wish.
The second benefit is that futures contracts are by nature ‘marked to market’ and enjoy favorable tax treatment. While a specific discussion is beyond my scope here, just know that any profits you make as a futures trader will be treated differently than if the same profit was earned in stocks or even similar ETFs (such as the DIA, QQQQ, or SPY). Specifically, futures profits receive “60/40″ treatment, where 60% of the profit is taxed at ‘long term capital appreciation’ which currently stands at 15%, and the other 40% is taxed as ordinary income, which can be greater than 33%. This simple benefit can save thousands of dollars a year in taxes over ETFs.
The third benefit is fluidity and liquidity. Now, few can argue that the major US market ETFs are not liquid, but often major futures contracts especially when trading smaller size are extremely liquid with a minimum of slippage. If you save even a penny (or more) of slippage in the futures vs ETFs per trade, then that as well can add up to hundreds or thousands of dollars per year.
The fourth benefit and danger is leverage.
Leverage deserves its own section. Again, I will speak only in terms of the Dow e-mini Contract.
One @YM contract is (in essence) equal to 500 shares of the Dow Jones EFT (DIA).
Because the @YM contract is 5 times the value of the Dow Jones Industrial Average, the current monetary value of a @YM contract is (approximately) 13,850 x 5 = $69,250.
People who begin futures trading might balk at this point. One contract currently controls approximately $70,000.
For an ETF trade in the DIA, it would require $70,000 to take on 500 shares which you can do on margin if your account is less than $70,000.
But how much do you need in your futures account to control $70,000 of ’stock’? Less than $3,000! This depends on your broker, but that is the approximate value.
Needless to say, if you are in a losing position, your account can be shattered quickly, because you are in essence trading 23 times your initial ‘position’.
A final point is that at least for my accounts at TradeStation commissions are half of what they would be for a round-trip trade.
A @YM trade costs approximately $2.50 to enter and $2.50 to exit. That’s a total commission of about $5.00 to control 500 ’shares’.
The subsequent position of 500 shares of the DIA ETF would be at TradeStation’s rate of $1 per 100 shares – $5.00 to enter and $5.00 to exit.
If you traded only the DIA for one year, and then only the @YM the next year, assuming all things are equal, you would save HALF of your bottom line on commissions for the year you traded futures.
Ever wanted to cut your commissions in half?
This isn’t intended to be a full report on futures trading. Futures trading involves specific risks that stock trading does not.
Futures trading is not for everyone, and is probably not for beginners, but experienced stock traders can benefit from studying the futures markets if they are mainly Index ETF traders.
Futures contracts are greater leveraged, (often) cost less in commissions, result many times in less slippage, and are treated more favorably than stocks.
If you haven’t considered futures trading, it’s worth studying.