Index futures are one of the most efficient ways to earn a consistent income as a day trader.
They also happen to be the least known product by the retail trader. However, these are the most liquid products in the market and are widely traded by institutions and professionals.
Let’s first talk about what an index is very briefly.
The Problem of Picking Stocks
When you first hear of the stock market, you immediately assume the job is to research companies and be able to pick the right one for the future.
This is a very labor-intensive process, and it requires knowledge of advanced security analysis. Even the best investors have a hard time predicting markets, especially in times of high economic uncertainty. You will always be reading through thousands of pages of financial statements.
You might be thinking, there has to be a better way?
Luckily there is.
- Imagine being able to trade the entire market, and not have to worry about an individual stock?
- Imagine not having to create morning watchlists, and constantly research company financial statements?
- Imagine just buying the entire market and making money as momentum moves in a few minutes to a few hours?
This is called index trading or investing.
Index Funds
You can learn more about index funds here before we talk about futures.
In short, index funds are vehicles that combine all the stocks in one product. Instead of just buying a company like Apple, you can easily buy all 30 companies on the Dow Jones for example.
- This means, that instead of trying to find stocks, you are instead investing and trading the overall momentum of the market as a whole.
- This is great news because there are 500 companies in the S&P 500 index, the benchmark for “stock market” performance today.
But how do you buy a basket of these stocks?
This is where we can finally talk about index futures.
Index Futures Basics
Futures are what’s called a derivative.
Derivatives are paper contracts that help you “rent” the stock instead of owning it and paying so much money upfront.
With index futures, you can actually rent all 500 stocks at once, without having to put down thousands of dollars to purchase just one share of each company.
There is a lot of confusion about futures in general with the retail investor.
But it really is as simple as getting to own the entire market with a small initial investment.
Index Futures Trade Example
So let’s imagine that you believe the market will go up today. You don’t have to worry about tomorrow or even next week.
Based on the news and your trading strategy, the outlook is for prices to go up during the day.
You decide you want to buy the entire S&P 500 index on the market open at 9:30 AM EST.
Keeping your risk small, you decide to buy only one contract of the S&P 500 futures(more on this in the next section).
Every contract you own gives you a return or loss of $50 USD per point.
By noon, your analysis was right – and the S&P 500 is up 30 points. This, by the way, is a typical amount on a daily basis. Some days it can be a lot more when there is uncertainty that creates volatility. But even on the quiet days, there is at least a 15 point opportunity.
How much money have you made?
Well, we said the return is $50 a point, so you multiply by 30 points to get a $1,500 USD profit, without ever having to spend time picking a stock.
How much capital did you need in your trading account to do this trade?
Only $400 USD!
That’s right, you made a 375% return in 2.5 hours.
This is the power of futures, and why most professional day traders prefer them.
Of course, if you are down 30 points, you lose the equivalent. However, with the risk management techniques we teach traders, you will NEVER be taking that kind of risk on one trade.
As a disciplined trader with an edge in your strategy, index futures are often unbelievable to new traders looking to pick stocks daily.
Now that you are thoroughly excited, and thinking about how to spend money you haven’t earned yet, let’s talk about what you are actually buying when you trade index futures.
Index Futures Contract Specifications (Specs) Intro
In the United States and North America, the biggest futures markets are traded on the Chicago Mercantile Exchange. Also called the CME.
You can visit the CME website by clicking here.
The contract I will be using to explain index futures is called the “ES”. This is the symbol for the S&P 500 index, which we used as an example prior.
One of the first things you want to look at is the contract specs.
I’ve attached an image below, including the link to go to the CME website directly to see the updated information.
Let’s go over these contract specs together, going one section at a time.
Contract Unit
This is the value of each contract. For the ES it is $50 USD a point, multiplied by whatever the trading price of the S&P 500 is.
Presently, it is trading at 4,600. Therefore the “value” of each contract is $230,000 USD ($50 x 4,600).
The good news is, that you DO NOT have to pay that much to trade this contract. Most brokers have margin requirements of $400 to $2000 USD per contract.
Source: CME Group, Click here to visit the page.
Trading Hours
The trading hours of the ES contract are the next thing you will see.
One of the biggest benefits of futures trading, in general, is that markets are open 23 hours a day, 5 days a week. This means you can be a futures trader while working your full-time job until you gain the confidence and experience to go full-time.
The ES contract opens Sunday at 6 PM EST and trades until Friday at 5 PM ES. The only interruption is a one-hour closure between 5-6 PM EST.
Source: CME Group, Click here to visit the page.
What a fantastic advantage!
How many times have you wished you could sell your stock as it’s puking lower, but you couldn’t because markets were “closed”? Only to see it down another 10% by the opening the next day.
How frustrating! I couldn’t ever imagine leaving that much trust in the market personally. And for this reason alone I am solely a futures day trader.
Minimum Price Fluctuation & Product Codes
This section refers to how much the minimal movement is that your contract can experience.
We are more interested in the outright section for now. Spread trading is a bit more of an advanced concept for another article.
The chart below from the CME shows that the outright minimum is 0.25 index points. This means that each point consists of 4 smaller values, called ticks. If one point is $50, and there are 4 intervals of 0.25, each tick is valued at $12.50 USD per contract. Hence, each point is $50.
The next section is the product codes.
S&P 500 futures have the symbol code of ‘ES’ as already mentioned. That’s all you need to take from this section.
Source: CME Group, Click here to visit the page.
Expiration and Settlement Method
Earlier we mentioned that futures allow you to “rent” the value of the stock market.
But for how long?
Derivatives differ from stocks, in that they have an expiry date and a finite life span. That’s because your rental period eventually expires. This is what makes them “cheaper” to trade than stocks.
If you wanted to own the stock forever, or even an index, you would definitely not be buying futures. The entire goal of futures is to rent the price so you can make a quicker trade and put the profit back into your account. Safe from the chaos of the stock market as you sleep.
Therefore, futures have an expiry date.
For the ES, the contracts are listed with quarterly expiries. These match the calendar year.
The expiries are on the 3rd Friday of each of these months every year:
- H: March
- M: June
- U: September
- Z: December
One easy way to remember these codes is the word “humus”. It isn’t an exact spelling, but it’s “hmuz”. And now you have your first bit of futures trader jargon.
The second part of the image below shows a term called “financially settled”.
In the simplest form, all this means that losses and gains are realized in dollars. Cash money.
What’s important to know, is that some contracts like oil, actually settle in physical barrels. This allows oil producers to hedge their commercial activity and move their products while protecting their price and revenue.
Take a look at the graphic below to see how it is listed on the CME website.
Source: CME Group, Click here to visit the page.
One thing new traders panic about is that some futures products have a physical settlement. Like oil.
I can assure you there is nothing to worry about. At any moment, you can sell any futures contract to close out the position and not have to take delivery of 1,000 barrels of oil.
In fact, almost all good brokers will automatically close out your position on the expiry date before the actual expiration. They do this to protect you, and themselves. If you do plan to take delivery, you can let them know and make an arrangement to let your contract settle instead of closing the position.
Basically, in futures, if you have two contracts you can always sell them to get back to neutral, even on expiry day, up to the last second of trading.
Final Thoughts on Index Futures
The scariest part of futures trading is when you are brand new.
The more you learn about them, the more shocked you are and wonder to yourself – “why the heck isn’t everyone trading futures”?
It’s a great question, and something we are hard at work to educate people about.
There is a reason professional traders use these products to amass windfall profits every year. The reason is that index futures are amazing to day trade, and even invest in.
Of course, it also means you’ll have to invest more time to learn and try something new. Ultimately, futures trading is more work to learn than simple stocks. But there is a reason for it, and the effort is well rewarded.
Remember the old cheesy saying your grandpa always said to you?
The only place success comes before work is in the dictionary.
You can always try aping into meme stocks that everyone is pumping on Twitter, but to build a sustainable career with unimaginable potential, there is nothing better than index futures trading.
Once you learn them, you’ll wonder why you didn’t before. And, you’ll finally understand how other people can have consistent success in the markets. You’ll find a career in this profession that you’ve been searching for.
Good luck and good trading, and I’ll see you on the ES ladder!
Recommended Reading
Learn how to start with small a risk using the micro futures.
Here is a step-by-step guide on how to become a successful futures trader.
Prefer crypto trading? Read about bitcoin futures.
Want a complete development plan, similar to those professional traders get at big institutions?
Check Out Our Futures Trading Course >>
If you want to join with us in our live trading room, Check This Out.
If you prefer to trade more passively, check out our newsletter, trade ideas and live analysis in the Elite Trader package here > for Free News Update Click here.
The information contained in this post is solely for educational purposes and does not constitute investment advice. The risk of trading in securities markets can be substantial. You should carefully consider if engaging in such activity is suitable for your own financial situation. TRADEPRO AcademyTM is not responsible for any liabilities arising as a result of your market involvement or individual trade activities.
