What it means
A futures contract is an agreement to buy or sell something at a set price on a future date, and the buyer and seller usually settle in cash rather than delivering the goods. Standard index futures were large, with each contract representing hundreds of thousands of dollars of stock value.
E-mini contracts were created by the CME Group, a major futures exchange, to be smaller and to trade electronically. The size is set by a multiplier, which is the dollar amount that each point of the index is worth.
For the E-mini S&P 500, the multiplier is $50 per index point, so if the index is at 5,000 the contract controls $250,000 of notional value (the total value of the position on paper). Contract specifications are set by the exchange and can change, so traders should check the current terms.
E-minis are traded on margin, which means the trader puts up a small deposit, called initial margin, rather than the full value of the position. This creates leverage: a small movement in the index produces a large percentage gain or loss on the deposit.
Leverage magnifies both profits and losses, and a trader can lose more than the deposit. Corporate finance teams and investment managers use E-minis for hedging.
A fund holding a diversified portfolio of shares can sell E-mini contracts to offset a temporary fall in the market without selling the underlying shares. Speculators use them to bet on the direction of the market, taking advantage of low costs and near round-the-clock trading.
There are E-mini contracts on other indices, such as technology-heavy or small-company indices, and on commodities and currencies. A still smaller version, often called a micro contract, is available for even smaller trades.
Before trading any futures contract, it is important to understand the margin rules, the daily settlement of gains and losses, and the risk of rapid moves.
In practice
Real-world examples.
Example
A pension fund holds $50,000,000 of United States shares and expects short-term turbulence. It sells E-mini futures with a notional value of $10,000,000 to offset part of the risk, and removes the hedge when conditions calm.
Example
A day trader buys one E-mini contract at an index level of 5,000 and sells it an hour later at 5,010. The gain is 10 x $50 = $500 before commissions and fees.
Example
A company that manages employee share plans wants to protect the value of a cash deposit that will be invested in the stock market next month. It buys E-mini contracts now so that it is not caught out if prices jump before the money arrives.
Formula
Calculation
Contract value = Index level x Multiplier
Profit or loss = (Exit level - Entry level) x Multiplier x Number of contracts (for a long position)
Worked example: the index stands at 5,000 and the multiplier is $50.
Contract value = 5,000 x $50 = $250,000
A trader buys 2 contracts at 5,000 and sells them when the index reaches 5,040.
Profit = (5,040 - 5,000) x $50 x 2 = 40 x $50 x 2 = $4,000
If the index had instead fallen to 4,960, the loss would be (4,960 - 5,000) x $50 x 2 = -$4,000.Case study
Seen in the real world.
Redwood Endowment Fund is a fictional charity with $80,000,000 invested in a portfolio of shares. The investment committee expected a volatile quarter but did not want to sell holdings and trigger transaction costs. Its adviser, Ms Hughes, proposed using E-mini futures to reduce exposure temporarily.
She calculated that selling 80 contracts with the index at 5,000 would hedge 80 x 5,000 x $50 = $20,000,000, a quarter of the portfolio. When the market fell 6% over the quarter, the portfolio lost about $4,800,000 in value, but the futures gain of roughly $1,200,000 offset a part of this.
This illustrative case shows that a hedge reduces risk rather than removing it, and that it also limits gains if markets rise. The committee agreed to review the hedge each month and close it when the outlook improved.
Watch out
Common mistakes.
- Focusing on the small deposit and forgetting that the full contract value is at risk, so losses can far exceed the margin.
- Assuming the E-mini is a share, when it is a derivative that is settled daily and expires on set dates.
- Ignoring the multiplier, which leads to misjudging how many dollars each index point is worth.
Questions
People also ask.
What does the "mini" refer to?
It refers to the contract being smaller than the original full-sized futures contract on the same index.
Can individuals trade E-minis?
Yes, through a futures broker, although brokers set their own account requirements and the risks are high.
What is a micro E-mini?
It is an even smaller contract, typically one-tenth of the size of an E-mini, designed for traders who want a lower exposure.
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