Day Trading Encyclopedia

Market Futures

Stock Market Futures

What Are Market Futures?

Stock market futures, also called market futures or equity index futures, are futures contracts that track a specific benchmark index like the S&P 500. While commodity futures require delivery of the underlying goods (IE: corn, sugar, crude oil), market futures contracts get settled with cash or get rolled over.

Market futures allow traders to trade the direction of the underlying equity index, hedge equity positions and be used as a lead indicator for the markets and stocks. Unlike options that can expire worthless when out of the money, expiring market futures are rolled over into the next expiration month contract. Market futures contracts expire on the third Friday of each quarterly month, starting from March. Expiring contracts are rolled over to the next expiration month on the second Thursday of the week. As the rollover approaches, the trading volume migrates from the expiring contract to the next expiration month contract, also called the front month. The following letters identify each expiration month: H for March, M for June, U for September and Z for December.


How Are Stock Market Futures Calculated?

Market futures fair value is often mentioned pre-market on various business channels each morning. The fair value is based on what the market futures contract should be priced at based on the current cash value of the underlying index. The formula to calculated the fair value of the S&P 500 futures contract is derived by taking the current S&P 500 index cash value multiplied by [1+interest rate (x/360)] – dividends of all the S&P 500 component stock dividends into front month expiration. The premium between the market futures and the fair value fluctuates throughout the day as institutional trading programs leapfrog each other to arbitrage futures versus cash premiums. Institutions buy and sell programs rock the markets like earthquakes during the trading day when the premiums become attractive.


How Are Market Futures Used?

Equity index futures don’t actually own any components of the index but instead tracks with the movement of the underlying index. In fact, they actually tend to lead the index moves. Market futures are incredibly liquid, especially the S&P 500 contracts. The E-mini is the electronic version of the S&P large contract trading at 1/5th the cost. A 1 point move on the big S&P 500 futures equates to a $250 profit/loss in value whereas the same 1 point move would be worth $50 in the S&P 500 E-mini.

Market futures contracts can be traded long or short to profit from directional moves. There are no up tick rules, which allows traders to short-sell on the inside bid prices instead of waiting to be filled on an up tick. They are widely used by portfolio managers to hedge both long and short positions. Institutional program trading will attempt to arbitrage the futures with the underlying index, also referred to as cash value. Buy and sell programs flood the market as they try to capture the premiums.


Continuous Market Futures Contracts

With futures contracts expiring every quarter, there is generally only three months of active trading data. This limited front month trading data can be prohibitive for wider time frames like weekly and monthly charts. Even shorter time frame charts suffer at the beginning of the front month futures contract cycle as indicators like moving averages require a minimum number of data periods to generate.

For this reason, there are continuous market futures contract symbols. As the name states, they are continuous with smooth historical data that allows for seamless charting from shorter time frames to wide time frames. The result is more accurate indicators. For example, a daily 5-period moving average would have limited data in the first week of a front month market contract, whereas the continuous contract would have more accurate moving average lines with plenty of data. Popular moving averages like the 50-period and 200-period daily moving averages require the continuous contract data. Check with your broker for the correct symbols for the continuous market futures contracts.


Popular Market Futures

The Standard and Poor’s 500 Index is the undisputed benchmark index for institutions and traders. The original S&P 500 large contract trades on the auction floor with prefix symbol SP. The Chicago Mercantile Exchange Group introduced a compact version called the S&P 500 E-mini, which trades at 1/5th the cost of the large contract. Traders migrated quickly to E-minis due to accessibility, liquidity, better leverage and affordability.

The S&P 500 E-minis are the most widely traded E-minis trading up to two million contracts a day, pre-fix symbol ES. The other popular market futures contracts include the Dow Jones E-minis symbol YM, the Nasdaq 100 index E-minis symbol NQ and the Russell 2000 E-mini symbol ER.