The S&P 500® index (SPX) measures the performance of 500 of the largest publicly traded companies in the United States. Representing U.S.-based companies with a combined value of more than $30 trillion at the end of 2022, the SPX was the ultimate measuring stick for thousands of funds and fund managers due to its broad exposure. Yet, for individual investors and traders, taking or unloading a position in specific S&P 500 companies may not always be feasible or desirable.
Futures based on the SPX and other equity indexes have historically been used by some traders looking for a way to gain exposure to the broader market, potentially help protect against market turmoil, and add portfolio flexibility during earnings season.
E-mini SPX futures have been traded for more than two decades. More recently, smaller, Micro E-mini SPX futures contracts have presented new potential opportunities for qualified retail investors and traders. Still, investors need to remember that futures are different from stocks. Futures trading involves substantial risk and is not appropriate for everyone, so it's critical to understand how futures work and be aware of the opportunities—and risks—before trading.
Trading S&P 500 futures
Let's go over the basics of how to trade SPX futures.
What is a futures contract and how do futures differ from stocks? A futures contract is a legally binding agreement to buy or sell a standardized asset on a specific date or during a specific month. Futures contracts are bought and sold mostly electronically on exchanges and trade nearly 24 hours per day. Trading futures requires opening an account with a registered broker. Unlike shares of stock, which in theory can be held forever, futures contracts expire in a specified month.
Commodity futures based on grain or crude oil offer the potential for "physical delivery," where the buyer takes possession of the commodity (and the seller must deliver the commodity). In contrast, equity index futures contracts, such as those based on the S&P 500, are "cash settled," meaning a cash position is transferred between the buyer and seller.
Among the many index futures contracts, why consider S&P 500-based futures?
Traditional E-mini S&P 500 futures, along with the newer Micro E-mini futures, are based on the underlying SPX and closely track the U.S. benchmark from day to day. Both the E-mini and Micro E-mini SPX futures trade on the Chicago-based CME Group exchange and are among the most actively traded futures in the world. So, historically, there's been liquidity for buyers and sellers to find each other and quickly and efficiently execute trades. That's one reason many professional portfolio managers and traders use SPX-based futures in an attempt to hedge against potential market downturns or insulate their portfolios against different types of surprise events.
What's the difference between E-mini and Micro E-mini SPX futures? "Smaller bite" micros require less money up front and can require less equity to maintain compared with traditional e-minis. For example, the maintenance margin—the minimum amount of money a trader must maintain after opening a position— currently (or as of February 2023), for one Micro E-mini S&P 500 futures contract (/MES) is $1,200. For the E-mini S&P 500 contract (/ES), the maintenance margin is $12,000 per contract.
The "multiplier" used to determine the notional value for Micro E-mini SPX contracts, at $5, is also one-tenth the size of the E-mini SPX contract. If the SPX is trading at 3,000, one Micro E-mini SPX contract would be 3,000 times the $5 multiplier, for a notional value of $15,000. The notional value of the E-mini SPX contract would be $150,000 (3,000 x the $50 multiplier).
How can trading SPX futures potentially help hedge a portfolio and maximize portfolio efficiency? S&P 500 index futures and other equity index-based futures may offer a way to help boost capital efficiency and hedge against market volatility.
One futures-based hedging approach involves calculating beta and beta weighting (beta measures the volatility of an individual asset, or an entire portfolio, in comparison to a benchmark like the SPX). Through beta weighting (available on many trading platforms), you can gauge your portfolio's theoretical risk relative to the S&P 500 or to a single asset. (To beta weight, you first determine delta, a measure of sensitivity to a dollar change in the underlying asset.)
If the broader market falls or rises X number of points, you can gain a theoretical sense of what such moves might mean for your portfolio balance. You can beta weight your entire portfolio, which could help give you a window into how your portfolio might be affected if there's an increase or decrease in the overall stock market.
Here's a simplified futures-based hedge example (Note: The following is an example of one strategy, but there are many strategies that exist.):
- Suppose you hold a stock position or a portfolio of stocks with a value of $50,000, and you're concerned about the prospect of negative surprises in upcoming economic reports or earnings season.
- You could hedge about 30% of that portfolio value by selling (or shorting) one Micro E-mini SPX futures contract by putting up the initial $1,200 maintenance margin, or about 8% of the $15,000 notional value of one Micro E-mini SPX futures contract ($5 x 3,000, using the numbers from the previous example).
- If the SPX drops 50 points (about 1.7%), and you then buy back, or close out (if possible), that futures position and pocket a gain of more than $200 that could help offset any paper losses in your stock portfolio. By taking a position in the futures contract, you gain similar notional exposure while tying up a lot less capital.
It's important to remember the risks involved in hedging strategies, like the example provided here. There is unlimited risk on a short position, as well as daily mark-to-market adjustments, and you may be required to add additional funds immediately or face liquidation. Leverage can be a double-edged sword where losses can be accelerated. Additionally, it's possible to lose more than the initial amount used to purchase the investment, so traders should consider these risk factors before selecting their strategy.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.
Futures and futures options trading involves substantial risk and is not suitable for all investors. Please read the Risk Disclosure for Futures and Options prior to trading futures products. Futures accounts are not protected by SIPC. Futures and futures options trading services provided by Charles Schwab Futures and Forex LLC. Trading privileges subject to review and approval. Not all clients will qualify.
The risk of trading futures can be substantial. The valuation of futures may fluctuate, and as a result, investors may lose more than their original investment. Investors must consider whether futures are a suitable investment for their own personal financial situation before trading. Past performance is not indicative of future results.
Charles Schwab Futures and Forex LLC makes no investment recommendations and does not provide financial, tax, or legal advice. Content and tools are provided for educational and informational purposes only. Any stock, options, or futures symbol displayed are for illustrative purposes only and are not intended to portray a recommendation to buy or sell a particular product.
Margin trading increases your level of market risk. Your downside is not limited to the collateral value in your margin account. Schwab may liquidate, without contacting you, to meet a margin call. Schwab may increase its "house" maintenance margin requirements at any time and is not required to provide you with advance written notice. You are not entitled to an extension of time on a margin call.
Investing involves risks, including loss of principal. Hedging and protective strategies generally involve additional costs and do not assure a profit or guarantee against loss.
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The S&P 500® is a product of S&P Dow Jones Indices LLC or its affiliates ("SPDJI") and has been licensed for use by Charles Schwab & Co., Inc. Standard & Poor's® and S&P® are registered trademarks of Standard & Poor's Financial Services LLC ("S&P"); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC ("Dow Jones"). Charles Schwab & Co., Inc. is not sponsored, endorsed, sold, or promoted by SPDJI, Dow Jones, S&P, or their respective affiliates, and none of such parties make any representation regarding the advisability of investing in such product(s), nor do they have any liability for any errors, omissions, or interruptions of the S&P 500.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.0223-3DT9