Mini and micro contracts likely have done more to open the world of derivatives to retail traders than almost any other innovation. Still, some traders may wonder why they should bother with mini contracts when full-size contracts are available, and they have the capital needed to trade them. However, rather than seeing the mini contracts’ smaller size as a negative, many traders prefer to focus on that aspect as a positive.
Because derivatives, like futures and options, are based on contracts with set specifications, size does matter and is something exchanges have to balance closely. “In the beginning we had the S&P; it was $500 a point. That got too big and CME had to reduce [the multiplier] to $250, then started the E-mini S&P,” says Jeffrey Friedman, senior commodities broker at RJO Futures.
Traders quickly realized that the smaller contract size opened up a number of opportunities for both small or large, novice or experienced, traders.
With mini and/or micro contracts available in products throughout the futures landscape and recently introduced in the stock options world, there are plenty of opportunities for new traders to learn the ropes without the risks associated with full-size contracts.
Looking at the S&P 500 traded at CME Group, the full-size contract has a multiplier of $250 while the E-mini contract’s multiplier is $50. This smaller size offers newer traders two distinct opportunities. First, it means smaller traders can participate in the markets and not get completely wiped out by a single trade that goes against them; and second, it provides a lower risk environment for traders to gain experience and develop their strategies. “The beginner can get a lot more experience once he starts trading while he develops the methodology and discipline for trading,” Friedman says.
Particularly, the smaller contracts allow newer traders to develop their risk control strategies while not getting wiped out in the process, says J.J. Kinahan, chief derivatives strategist at TD Ameritrade. “One of the things we stress in our education programs is that it’s not that difficult to become a bigger trader when you’ve had some success. What is difficult is to trade too big at the beginning and then try to ‘make it up’ with bigger trades later even though you’re struggling,” he says.
In addition to mini contracts on stock index futures, exchanges offer mini and even micro contracts on many commodities, such as oil, gold and soybeans. The difference in contract size between the full-size and mini contracts varies based on the commodity. For example, a full-size corn contract at CME Group is for 5,000 bushels and the mini is for 1,000 bushels, whereas a full-size gold contract is for 100 troy ounces, the mini is for 50 troy ounces and the micro is for 10 troy ounces.
Some traders that intend to take delivery eventually, but don’t have the capital to do so immediately, will use mini contracts to build a position that they later can roll into a full-size contract to take delivery. Looking at gold again, this means a trader can buy a couple micro contracts to gain exposure to gold and add to his positon later until it is large enough to roll into a full-size contract to take delivery.
On the stock options side, mini option contracts were launched in March in some of the most popular equities, including Apple, Google, Amazon, GLD and SPY, and have an underlying of 10 shares rather than the 100 shares of a full-size contract.
Kinahan says the launch of these products allows someone who has never traded an option before to more easily gain experience because they still have the same mechanics as their full-size counterparts. “What’s beautiful about the minis is they are a completely separate class of product because they let people with smaller amounts of capital play in some of the bigger assets, like the Apples of the world that everybody wants to trade. They allow you to do so in a risk-defined environment with less capital,” he says.
Friedman does not see such a need for the mini options contracts because options already offer a range of products to manage your risk. “My attitude is when talking about options, sometimes you don’t need a mini option because you can get a little further out-of-the-money with a put or call or different strategies to reduce your exposure. Depending how you manage your exposure, you might not need a mini option,” he says.
Ladder in, ladder out
Although many newer traders use mini contracts to gain experience, many more experienced, professional traders use them as well, both because they can offer opportunities to scale in and out of trades, and because many mini contracts are extremely liquid.
One of the biggest advantages Friedman identifies about mini contracts is the flexibility they afford traders when they are entering or exiting a position. Especially for position traders who can’t watch the market all day, he says minis offer the opportunity to ladder in or ladder out of bigger positions. “With mini contracts, you are able to take off some contracts to take a profit when you have multiple contracts on. If you have just one large contract, you don’t have that flexibility,” he says. “With minis, you can lower your stop, and because you have some equity still in the trade, you still can go with it.”
This means traders have more options when entering or exiting positions. For example, instead of trading a single S&P 500 contract, a trader could trade five E-mini S&P 500 contracts for the same risk exposure. Then, when the market moves in the trader’s favor, rather than having to decide when to exit his entire position with the full size contract, he can choose to take profits on one or two E-mini contracts while letting the rest of his position ride the move (see “Don’t miss your exit,” below).
Finally, many mini futures contracts have attracted huge amounts of liquidity, especially the E-mini S&P 500 (see “Trader’s view of the world,” April 2013), which is traded completely electronically; the full-size S&P 500 still has an open outcry session during the day. “More volume attracts even more volume,” Friedman says. “I like to know that other people are participating. If you can’t find a market, you can’t maneuver. It’s hard enough getting the right market, you don’t want another hurdle.”
Although the mini contracts are smaller than their full-size brethren, that does not mean they are any less important, especially to retail traders. Kinahan says exchanges have done a very good job educating retail traders about how futures easily can supplement their portfolios with mini contracts. He uses the example of someone who has a nice retirement portfolio, but is worried that the market may go down. Rather than selling the holdings, he now might sell some E-mini S&P 500 contracts to hedge the position. This way even if the market moves down, he will make some of it up from the E-mini shorts.
Ultimately, exchanges and brokers have realized one of the keys to gaining retail trading participation is creating contracts that these traders want and can afford to trade. By focusing on education, mini contracts have helped transform the image of futures and options from gambling products to hedging vehicles.
Innovation always has been a hallmark of the futures industry. As exchanges continue to look for ways to engage retail traders, we can be sure that mini and micro contracts have a bright future.