S&P 500: futures vs. options

August 22, 2016 01:00 PM
In the past five years, there has been a return to the futures market by retail traders, who have grown to have virtually the same market presence as elite traders.
S&P 500: futures vs. options

S&P 500: futures vs. options

In the past five years, there has been a return to the futures market by retail traders, who have grown to have virtually the same market presence as elite traders. CME Group said in its first quarter earnings call, “In Q1 we had more than 10% growth from asset managers, hedge funds, corporates, proprietary trading firms and retail clients...” Three years ago, retail traders would not even be considered in such a statement.

The fact that retail traders are now thought of as a major contribution to volume growth is a giant breakthrough.

The main catalyst for such a breakthrough is access.  Until recently, electronic efficiencies were limited to institutional traders. Now, retail brokerage firms are streamlining the process to trade stocks, equities, equity options and futures from just one platform. The speed and ease of electronic execution for futures has opened the door to allow almost anyone to apply strategies that were once only traded by professionals. What many stock-focused traders may not yet realize though is that they can utilize the same strategies they have been trading for years in stock options, more efficiently with options on futures.

An option is an option regardless of the underlying instrument. This means that you can still apply risk defined strategies while trading futures products.

A vertical is a vertical, and a butterfly is a butterfly, and so on and so forth.

So, let’s compare the most actively traded overall market, the S&P 500 – as both an equity option, and an option on a future.

SPX options are traded exclusively on the Chicago Board of Options Exchange (CBOE) and have physical market makers standing in the pit as well as extended market hours. Markets often trade in nickel increments instead of the desired penny increments. SPX options trade fewer hours than equity option futures. During major world events, like the recent Brexit vote, the majority of the market movement happened while the U.S. equity markets were closed. With access to the futures markets, any trader can seize the opportunity to place an opening trade, or take risk off the table during the overnight session. Futures markets are open 23.5 hours a day for six day a week, whereas SPX options are open 13 hours five days a week. Options on E-mini futures allow traders nearly constant access, and the ability to react to any fundamental event or price movement.

The E-mini futures and E-mini options are the most actively traded contracts at CME Group. Inclusive of all the option expirations offered, they account for a daily average volume year-to-date of approximately 250,000 contracts. There is a liquid one-tick range.

Comparing the “at the money volume” and “open interest” on both products, shows more liquidity in the futures options. On Friday, June 24, the day of the Brexit results, the E-mini options hit a record high Open Interest of 1.26 million.

However, the greatest efficiency trading the E-mini options over SPX is margin.

Let’s break down a very commonly traded option strategy, the vertical spread. The focus will include all three areas of a risk defined strategy: profit and loss parameters, and the margin required on a 10-point bear call spread on both products (see “Tale of the tape” below).

It is important to also note that SPX is a cash settled product, and while dependent upon the option expiration you are trading in, the E-mini may exercise into an outright futures contract. Also, SPX is a European style option contract, while the majority of the E-mini expirations settle American style. However, both can be exited at any time prior to expiration. Something to keep in mind when trading any futures option is that they are a one-to-one equivalent as opposed to equity options being one to one hundred equivalent.

Based on the opportunities highlighted herein, and retail growth numbers becoming visible alongside traditional significant market participants like asset managers, hedge funds and corporates – it seems likely that futures and futures options continue to become increasingly attractive to more and more retail traders

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