Article is contributed by CME Group
Introducing the E-Mini S&P 500, Dow and NASDAQ-100 stock index futures
You can gain exposure to the U.S. stock market by trading U.S. Equity Index futures. Among the most liquid of these futures are the E-mini S&P 500 futures (Bloomberg Code: ESA), DJIA futures (DMA) and NASDAQ-100 futures (NQA) listed on CME Group exchanges. How do you decide which one best meets your investment criteria? This article provides a brief introduction to these futures contracts.
The first thing to understand is the difference between which segments of the economy each index aims to represent and how the index is constructed. Stock indices trace their origin to Charles Dow and Edward Jones who founded the Wall Street Journal in 1884, and published the DJIA in May 1896.
The Dow Jones Industrial Average (DJIA) is a stock index that tracks U.S. stocks that are considered to be leaders in the economy. It is a price-weighted average of 30 stocks that are publicly listed on the NYSE or NASDAQ. The editors of the Wall Street Journal pick the stocks which comprise the DJIA. The selection is subjective, and the stocks represent some of the largest companies in the U.S. across a broad range of industries, excluding transport and utilities.
Given that some stocks included in the index may split over time, the calculation of the DJIA is not as simple as just adding up the stocks and dividing by 30. The divisor is regularly adjusted to account for stock splits and stock dividends when they occur, in order to maintain the continuity of the DJIA. For example, the Dow Divisor was 16.67 in 1928, and is currently 0.1557… (to 14 decimal places). The method of constructing the index and the divisor is published by S&P Dow Jones Indices.
The Standard & Poor’s 500 (S&P 500) is a market capitalization-weighted index of 500 stocks. The S&P committee selects the 500 from the list of companies considered representative of the U.S. equity marketplace as a whole. Like the DJIA, the S&P 500 is also maintained by S&P Dow Jones Indices, and the component companies are selected by committee. The committee selects the companies in such a way that the index is representative of the industries in the U.S. economy. Like the DJIA, the stocks must be publicly listed on the NYSE or NASDAQ. To be included into the S&P 500 index, the selected companies must also satisfy certain pre-defined liquidity and market capitalization criteria.
The S&P 500 and the DJIA are the two most widely known stock indexes. The S&P 500 is the leading large-cap benchmark for the U.S. stock market and is the main barometer for institutional and professional investors. The DJIA is a popular measure of the U.S. stock market, especially among the media and general population. The S&P 500 vs DJIA is one of the most popular spreads because the two indexes are closely related – but not 100 percent correlated. Given that the DJIA has only 30 stocks, it is also feasible to monitor the main stocks that may have an impact on the spread relationship.
The NASDAQ- 100 is a market capitalization-weighted stock market index made up of about 100 (currently 102) stocks of the largest non-financial companies listed on the NASDAQ. The key difference from the other two indices is that it includes non-U.S. based companies which are listed on NASDAQ. Non-U.S. incorporated component stocks in the index include Baidu (China), Vodafone (UK), Seagate (Ireland), Avago (Singapore) and Garmin (Switzerland).
The second thing to appreciate is how each index responds to major political and economic events.
Theoretically, the S&P 500 is the most representative index of the U.S. stock market, as it incorporates a much larger sample of U.S. stocks. The DJIA is price-weighted, so the index is more greatly affected by movements in the higher-priced stocks in the index. The NASDAQ-100 if often considered a reasonable proxy for high-tech stocks because the NASDAQ marketplace has traditionally been dominated by high-tech issues and because the index specifically excludes financial stocks.
Still, there are strong correlations between the movements in all three of these U.S. “macro” stock indexes. All three indices will respond to significant changes in global political and economic events which affect the U.S. economy. Investors trade U.S. equity indices to gain an exposure to the broad trends in the U.S. stock market.
The historical price chart comparing the three indices demonstrates this high degree of correlation. For visual comparison, we have “normalized” the prices, so that each as the same base value of 100 as of our starting date, which we have arbitrarily chosen to be 1 August 2013.
We can clearly see that all three indices have reacted in a similar way to major events, such as geopolitical crises, U.S. political events, monetary policy decisions by the U.S. Federal Reserve, etc. Due to its relative larger exposure to emerging market and high-tech stocks, the NASDAQ-100 index has exhibited larger percentage price movements, compared to the S&P 500 and the DJIA during the period observed. Investors who bought E-mini NASDAQ-100 futures as an investment proxy would have realized a higher return during this time period, relative to E-mini S&P 500 or E-mini-DJIA futures.
Investing in CME E-minis
You can invest in a U.S. stock index by buying the individual stocks that comprises of the index, or by holding an equity index futures contract, such as E-mini stock index futures offered on the CME Globex® electronic trading platform.
Why might one invest in a stock index instead of buying individual stocks? Per the Efficient Market Hypothesis theory, an investor will not able to beat an efficiently priced market consistently, after adjusting for transaction costs. Empirical studies confirm that index funds routinely beat the plurality of actively managed mutual funds. By any measure, the U.S. stock markets are extremely liquidity and highly efficient markets. The Standard & Poor’s 500 (S&P 500) and Dow Jones Industrial Average (DJIA) indices are benchmarks that are frequently deployed as proxies for the U.S. equity marketplace.
Futures contracts on the three major indices – the S&P 500, DJIA and NASDAQ-100 – are available for trading through CME Group. They are available as standard sized contracts and E-mini contracts. The E-mini futures are one-fifth the size of the corresponding standard index futures. Like other stock index futures at CME Group, they are settled in cash to the spot value of the index. E-mini contracts are offered exclusively on the CME Globex electronic trading platform.
During the past three months, the average daily trading volumes of E-mini futures have been approximately $150 billion in E-mini S&P 500 futures, $20 billion in E-mini NASDAQ-100 futures, and $11 billion in DJIA futures. The liquidity offered by CME Group E-mini futures may be one of the most important reasons traders choose to invest in the broad U.S. stock market through E-minis.
When trading the E-Minis, note that stock index futures contracts are cash-settled (generally) on a quarterly basis in the contract months of March, June, September and December. Of course, you could trade a futures contract for a deferred delivery month. However, the “front-month” contracts typically attract the greatest amount of trading interest and liquidity.
Because futures are not perpetual and expire in a specified contract month, you must “roll-over” your position if you intend to maintain a “buy and hold” strategy. This implies that an investor will incur trading costs reflected in the width of the prevailing bid/offer spread as well as brokerage commissions and exchange fees. However, the average holding period for E-mini futures (S&P 500, DJIA and NASDAQ-100) is about 2 days, so for typical E-Mini traders, this is usually not a concern.
E-Mini Contract
S&P 500
DJIA
NASDAQ-100
Contract size
$50
$5
$20
Index level
1,990
17,000
4,090
ADV (000 lots)
1,512
137
241
ADV (000 lots)
150.4
11.7
19.7
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Futures and swaps trading is not suitable for all investors, and involves the risk of loss. Futures and swaps are leveraged investments, and because only a percentage of a contract’s value is required to trade, it is possible to lose more than the amount of money initially deposited for a futures and a swap position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one trade because they cannot expect to profit on every trade.
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