Based on the same underlying indexes as larger contracts, mini equity index futures have the same advantages that come from trading large portfolios of equities with a single futures or options contract. The mini contracts carry lower margin requirements and, at the same time, provide significant leverage in being able to exploit market price changes at a moderate cost.
Trading risk in mini options is reduced because of the smaller price change per option point — $50 for the S&P 500 E-mini (vs. $250 per point for the full-size futures contract), $5 for the E-mini Dow options, $20 for the E-mini Nasdaq 100 and $100 for the Russell 2000 mini.
One factor that is critical whenever you trade equity options is volatility. Although each stock index includes a broad range of equities, there are differences in volatilities perceived by the options market, as shown on “Stock index minis” (below). The Russell 2000 mini index achieves the highest call option valuation for September 2012 futures on May 31, 2012. As shown on the chart, the Russell 2000 call premium is approximately 6% of the strike price at the point at which the futures price equals the strike price. The second most valuable because of volatility is the E-mini Nasdaq 100 with a price curve height of 5%. These options are followed by the E-mini S&P and E-mini Dow, with the lowest price curve at 4% of the strike price.
This means that as time to expiration grows shorter, the mini Dow September calls will expire with a value of either zero or intrinsic value (futures price less strike price) well before a similar loss of time-premium value for the higher-priced calls for the mini Russell 2000 and Nasdaq 100. Only changes in portfolio composition or market perception of the indexes themselves could change the progression of call prices as the four “waves” move toward the “shore” represented by the horizontal axis and intrinsic value.
At the heart of this difference in market perception of relative volatilities among the four mini call options is the actual performance of the index futures. “Cumulative percent changes” (below) shows the price changes for the September futures from April 3 to June 5, 2012. During this period of overall declining stock prices, the Russell and Nasdaq September minis raced each other to the bottom, followed by the less-volatile Dow and S&P 500 minis. From Jan. 4 to March 30, the indexes showed approximately the same pattern with positive percentages: Dow, +6.94%; S&P 500, +10.68%; Russell 2000, +11.39%; and the Nasdaq 100, +18.16%.
Spreading opportunity
The close correspondence between percent changes in Nasdaq 100 and Russell 2000 mini futures, shown on “Daily percent changes” (below) suggests the possibility of spread trades. We can use options to take advantage of this relationship. Over the two-month period, there are several dates on which the percent changes diverge and then return to small or zero differences. Plus or minus changes larger than 2% were reversed in relatively short times.
Even more closely related are the combinations of the S&P 500 and Dow Jones Industrial Average, along with their associated mini futures and options. When the primary futures contracts are out of sync with the minis, it is possible that corrections in pricing will lead to spread profits.
“Spreads on curve variations” (below) shows that September call prices for the S&P 500 futures and mini contracts predicted by regression analysis are close to the market prices at each strike price in terms of option points. When the differences from predicted prices in option points are multiplied by the dollars-per-point — $250 for the S&P 500 and $50 for the S&P 500 E-mini contract — the variations often are interesting from the viewpoint of spread trades.
The example highlighted is the 1345 strike price on May 31, when the S&P 500 index September futures is 1302.60 and the E-mini S&P is 1305.50. Variations from the predicted price curve are small — 0.56 points for September S&P 500 and 1.80 points for the mini call. Converted to dollar differences, these become minus-139 and plus-90, suggesting a buy for the underpriced 1345 S&P 500 September call and a sale of the overpriced mini call at the same strike. The purchase of the S&P 500 call costs $10,175 premium, and five of the mini calls are sold at $2,113 each for an offsetting credit of $10,565.
On June 7, 2012, the spread trade is reversed, with the S&P 500 September 1345 call priced at 38.90, or $9,725, and the S&P 500 mini call at 39.00 or $1,950. The spread profit, $365, depends on the trader being able to buy and sell at the prices listed. Because CME Group and Barchart.com (the data used for this analysis) show non-traded options at theoretical values, it is probable that strikes having larger variations from predicted price curves actually are traded and provide possible bases for spreads.
Finding breakeven
The regression analysis that produces predicted call prices for each strike price also generates upper and lower breakeven prices — the futures price at expiration that will result in a zero gain or loss from a delta spread. For example, at the 1345 strike on May 31, the upper and lower breakeven prices for the S&P 500 futures contract are 1486 and 1228. These prices closely approximate those of the E-mini S&P 500: 1480 and 1226.
The delta ratios, or slopes of the call price curves at the 1345 strike price, are 0.546 and 0.532 for the calls on the S&P 500 and the E-mini futures, respectively. With a delta of 0.54, holding 1.85 calls against a short-sale of one futures contract should result in an approximate zero gain or loss at expiration.
The call price regression analysis also indicates how much price change the market expects before expiration in terms of an annual percentage rate. The result should be similar to the calculation of the closely watched volatility index (VIX). The similarity is only approximate because the VIX is computed based on a number of S&P 500 options with different expiration dates — and then adjusted for time spans to compute an annualized price change expected by the options market.
Using the upper breakeven price for the 1345 strike described for the S&P 500 September calls on May 31, 2012, an expected annualized price change may be calculated. The gain from a current futures price of 1302.60 to the upper breakeven price, 1486, is 14.08%. This percentage may be annualized by multiplying by a ratio based on the square root of time — 106 days to expiration vs. 365 days in a year. The ratio is 19.104 to 10.296, or 1.855. Applying the time ratio to 14.08%, the annual price change expected by the options market (according to the options regression price curve for a single time to expiration) is 26.12% for the S&P 500. On May 31, 2012, the VIX ranged from 22.78 to 25.46.
Using the same method, annualized expected price changes may be computed for the mini futures and options. This results in the annual percentages below on May 31, 2012. Relative price volatilities also are shown by the height of call price curves as a percentage of the strike price.
| Mini | Annual % variability | Height of call price curve |
| S&P 500 | 21.81% | 4.61% |
| Dow | 24.12% | 4.48% |
| Nasdaq 100 | 27.92% | 5.45% |
| Russell 2000 | 29.09% | 6.41% |
The percentages refer to the mini futures contracts that show approximately the same volatilities as the full-size versions. It should be noted that although increased volatility makes options more valuable, the percentages imply the possibility of decreases as well as increases in the price of the underlying futures.
Mini futures and options give traders a complementary set of equity index derivatives that are useful for outright buy and sell decisions and in developing spread trades. There frequently are variations from theoretically correct prices that may lead to profitable trades when prices move toward expected values.
Paul Cretien is an investment analyst and financial case writer. His e-mail is PaulDCretien@aol.com.
