Pricing E-mini and ETF opportunity

February 28, 2014 06:00 PM

Four stock indexes — the S&P 500, Nasdaq 100, Dow 30 and Russell 2000 — each have futures and options that have the trading advantage of being valued according to the same underlying index. The S&P 500 has the SPDR E-mini S&P 500 futures and SPY exchange-traded fund (ETF). The Nasdaq 100 has the E-mini Nasdaq 100 futures and QQQ ETF. The Dow Jones Industrial Average has the mini-sized Dow 30 futures and DIA ETF. The Russell 2000 has E-mini Russell 2000 futures and IWM ETF.

Each of the four futures contracts has an exchange symbol and a multiple number of dollars per option point. In a separate valuation mode, ETFs are priced as shares in funds that are based on the indexes. ETF share prices are more akin to common stock prices and are traded easily on various stock exchanges. They are as follows:

  • E-mini S&P 500 (ES): $50 per option point
  • E-mini Nasdaq 100 (NQ): $20 per option point
  • Dow 30 mini (YM): $5 per option point
  • E-mini Russell 2000 (TF): $100 per option point

The stock indexes corresponding to the E-minis are SPX, NDX, DJIA and RUT. SPY is one-tenth the size of SPX. QQQ is one-fortieth the size of NDX. DIA is one-hundredth the size of DJIA. IWM is one-tenth the size of RUT. 

Volatility differences

“Calls on E-mini futures” (below) shows the call option price curves for the four index futures with the September 2014 expiration date. Because the time to expiration is equal for the calls, different volatilities are the reason for varying heights for the curves. On Dec. 31, 2013, the options market considered the Russell 2000 index to be the most volatile and, thus, deserving of the highest options valuation. Next in line is the Nasdaq 100, followed at some distance by the S&P 500 and Dow Jones Industrial Average.  

While the indexes show a considerable spread between options price curves due to volatility, the individual pairs of E-mini futures and ETFs tend to have options price curves that are almost identical. A typical comparison is shown on “E-mini vs. ETF” (below). The curves are close enough to calculate the option prices for the E-mini by using the ETF call pricing equations and vice-versa.

On Dec. 29, 2013, the SPDR S&P E-mini December 2014 futures were priced at 1816.25, or $90,812.50 with the $50-per-point multiplier. On the same date, the 1990 calls had a price of 66 option points, or $6,600. By the regression options price model, the predicted price was 66.1618 with a delta slope at the 1,900 strike of 0.510.

A delta-neutral trade, with one long futures contract against the sale of two calls, would result in 2 x 66 x $50 = $6,600 in calls, hedging one futures contract on Dec. 29. On Jan. 6, 2014, the December 2014 E-mini S&P 500 futures contract was priced at 1,801 or $90,050, for a short-term loss of $762.50. On Jan. 6, the 1,900 calls were 59, or $5,900 for a short-term gain of $700 on the short sale. The delta-neutral trade depends on decay in the options value over time to increase the spread profit as the sold calls offset losses on the futures.   

Collective behavior

“Cumulative changes” (below) shows SPY, QQQ, DIA and IWM daily over the year 2013. These reflect the changes that would be noted in the underlying indexes. During the year, the ETFs gained from 25% to 30% in price, with the highest gain belonging to the Russell 2000 ETF, IWM, and the lowest going to the Dow 30 ETF, known as the Diamond or DIA.

It is noted that ETF prices tend to move together with changes in leadership occurring within a fairly narrow band of cumulative percentage changes. At times during the year, the price changes drop more sharply and cluster together more tightly. The tightening is followed by a series of price changes that are more spread out before narrowing into the next decline.

Birds do it, bees do it, so why shouldn’t traders do it? We’re talking about collective behavior.

The characteristic of narrowing and widening in the cumulative percentage price changes is similar to the collective behavior shown by schools of fish (schooling or shoaling), flocks of birds and swarms of bees. As the narrowing occurs, the individual members (in this example, ETFs) reach a point of “revulsion” and force their way to a greater degree of separation. There follows a period of “alignment,” in which the ETFs move together toward the next peak. It is then that there is a move to “attraction” with the narrowing of space between the ETF price changes leading to the need to separate once more.

The revulsion, alignment and attraction series is repetitive, as shown by the cumulative percentage changes. To find the points at which trades might be based on the concept of collective behavior, the differences between cumulative percentage price changes for each ETF and the three others in the sample are summed each trading day during 2013. The result, shown on “Summed differences” (below), indicates several times during the year where the difference (or space between the individual indexes) is small, suggesting “revulsion” and the need for more space and widening. This is indicated by sums of differences that equal approximately 15% or lower.

At the opposite extreme, there are several times when the summation of differences peaks above 25%, indicating a potential movement to a closer relationship, or “attraction,” between the ETFs. 

The second chart in “Summed differences” shows the spreads between cumulative percentage changes for the S&P E-Mini and the other three E-Minis. The final chart contains the remaining three differences. The peaks and valleys of the individual summations correspond in most cases with the first chart in the graphic.  For example, on June 10, with the DIA-IWM difference near zero and indicating a possible widening between percentage price changes, a trader might have sold DIA at $150.20 and bought IWM at $97.73. The trade would have been closed out on Oct. 15 with DIA at $150.52 and IWM at $106.75, for a net gain of $9.02.  

The universe of E-minis and ETFs is much larger than the small samples described here, but the principal advantages to traders remain the same. ETFs are easy to trade, and with increasing volume of trading they promise improved liquidity — although it’s prudent to check on daily volume and open interest before committing funds. As shown here, E-mini futures are more expensive, but offer advantages to institutional traders. Retail investors should be grateful to the innovators of products that expand the trading power of both large and small futures and options traders.

Paul Cretien is an investment analyst and financial case writer. His e-mail is 

About the Author

Paul Cretien is an investment analyst and financial case writer. His e-mail is