Pete talks about riding the wave on the grain report and what is going on today from Greece. He also introduces other S&P 500 vehicles to introduce a new equity index pairs trade.
Equity index futures offer investors a lot of leverage on the most popular indices. Trading index futures can be a little challenging if you do not understand the leverage that trading these products comes with.
In this episode of Splash, Pete looks at the main index futures: E-mini S&P 500 futures (/ES), E-mini Dow Jones Industrial Average futures (/YM), E-mini Nasdaq Futures (/NQ), and E-mini S&P MidCap futures (/EMD). Each future has a contract specs that are a bit different. Some have different multipliers (amount of leverage), notional values, and tick sizes. That information can be found below:
E-mini S&P 500 Futures (/ES):
Index Multiplier (leverage) - $50
Current Price - $2064.50
Notional Value - $103,225* ($2,064.50 x $50)
Tick Size - .25 ($12.50/tick)
E-mini Dow Jones Industrial Average Futures (/YM):
Index Multiplier (leverage) - $5
Current Price - $17,631
Notional Value - $88,155* ($17,631 x $5)
Tick Size - 1 ($5.00/tick)
E-mini Nasdaq Futures (/NQ):
Index Multiplier (leverage) - $20
Current Price - $4,404.75
Notional Value - $88,095* ($4,404.75 x $20)
Tick Size - .25 ($5.00/tick)
E-mini S&P MidCap Futures (/EMD):
Index Multiplier (leverage) - $100
Current Price - $1,507.50
Notional Value - $150,750* ($1,507.50 x $100)
Tick Size - .1 ($10.00/tick)
As you may have expected, these four indices are all highly correlated, meaning they typically move in the same direction.
When looking at 6 month correlations (longer term), /EMD and /ES have a correlation of .92. The 1 month correlation (short term) between /EMD and /ES was .84, which represents a divergence of .08 between the 6 and 1 month correlation. Knowing this, can we take advantage of the short term divergence to find trading opportunity.
To capitalize on the divergence between /EMD and /ES, Pete sells 2 /EMD futures and buys 3 /ES futures, effectively creating a futures spread. The reason he chose 2 and 3 contracts is because they both come out to about the same notional value (around $300k).
Placing the trade takes a large chunk of buying power - around $30k. Is there a way to place a notionally equivalent trade using less buying power?
As a matter of fact, there is. To do so, Pete uses /EMD futures and /ES options on futures. He sells 1 /EMD futures and buys 3 ATM calls (with an expiration near the same expiration as the futures contract). This reduces the necessary buying power to about $16k, which is about half of the original trade.
Strategies:Futures Spread, and Futures w/ Options On Futures Spread
Products Discussed In This Episode:/ES, /YM, /NQ, /EMD
*Values subject to change based on where the market is at
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