Equity Index Futures

What you will be able to do

• Choose between the E-mini and Micro contracts on the main U.S. stock indexes.
• Calculate the fair value of an index future and explain the basis.
• Read the pre-market futures correctly.
• Use the overnight high and low in your plan for the day.
• Compare a futures position with an ETF position, and hedge a stock portfolio with futures.

The four U.S. index families

Index	E-mini	Point value	Micro	Point value	Character
S&P 500	ES	$50	MES	$5	The benchmark; the deepest liquidity in the world’s futures markets
Nasdaq-100	NQ	$20	MNQ	$2	Large technology companies; faster and more volatile
Russell 2000	RTY	$50	M2K	$5	Small companies; sensitive to interest rates and the U.S. economy
Dow Jones Industrial Average	YM	$5	MYM	$0.50	30 large companies, price-weighted

All of them are cash-settled, expire on the third Friday of March, June, September and December, and trade on the 6 p.m. to 5 p.m. New York day (Class 5). The Micros follow their E-mini exactly at one-tenth of the size.

How big are the daily moves? Suppose the S&P 500 moves about 1% on a typical day. At 6,000, that is 60 points:

• 1 ES: 60 × $50 = $3,000 a day.
• 1 MES: 60 × $5 = $300 a day.

Before choosing a contract, compare that typical day with your account. For most individual accounts, the Micro is the right starting size.

Fair value and the basis

Why does the December S&P 500 future trade above the index? Because owning the future instead of the 500 stocks has two effects until expiration:

• You keep your cash, which earns interest. That makes the future worth more.
• You miss the dividends the stocks pay. That makes it worth less.

The price at which neither owning the stocks nor owning the future is better is the fair value:

fair value ≈ index × [1 + (interest rate − dividend yield) × days ÷ 365]

Example: S&P 500 at 6,000.00, interest rate 4.0%, dividend yield 1.2%, 58 days to the December expiration:

6,000 × (0.040 − 0.012) × 58 ÷ 365 = 6,000 × 0.028 × 0.159 = 26.70 points

Fair value = 6,000.00 + 26.70 = 6,026.70

The difference between the future and the index is the basis. Here the fair basis is +26.70, and it shrinks toward zero each day as expiration gets nearer (Class 4). It is also why the next contract trades higher than the expiring one at the roll.

“Futures are up before the open”

Television and websites quote the index futures before the stock market opens: “S&P futures are up 15 points.” The professional reading is relative to fair value:

• If the December ES is at 6,041.70 while the index last closed at 6,000.00, the future is 41.70 points above the close, but only 15.00 points above fair value (6,041.70 − 6,026.70).
• That 15-point premium to fair value is the market’s estimate of where the index will open: about 0.25% higher.

Many sites show “S&P futures vs. fair value” for exactly this reason. If you compare the futures with yesterday’s index close without removing fair value, you will think the open will be stronger than it is.

The overnight session and its range

Because the index futures trade from 6 p.m. the evening before, by 9:30 a.m. they have already had a session of their own. Its overnight high and overnight low (often called the Globex high and low) are widely watched:

• The open of the U.S. stock session often tests one of them in the first hour.
• A U.S. open outside the overnight range is a sign of strong pressure in that direction.
• A U.S. open inside it often means a quieter, two-sided morning until one of the edges breaks.

This is the same idea as the boxes in Outer Box Foundations: the overnight session is a box, and its high and low are levels the next session reacts to. Class 10 places it inside the daily box properly.

Futures against the ETF

Many traders already use SPY, the S&P 500 ETF. How do they compare?

	1 MES at 6,000	SPY shares of equal size
Market exposure	$30,000	About 50 shares at $600
Money required	Margin only (a few thousand dollars, set by the exchange and broker)	$30,000 in cash, or half on margin
Hours	About 23 hours a day, five days a week	Regular hours plus limited extended hours
Short selling	As easy as buying	Needs shares to borrow; extra rules
Dividends	None; built into the price (fair value)	Paid to holders
Expiration	Must be rolled each quarter	None
U.S. tax	Section 1256: 60% long-term, 40% short-term	Short- or long-term by holding period

Neither is better in general. Futures are more capital-efficient, trade longer hours, short easily and may be taxed more favorably for short-term trading; the ETF never expires, pays dividends and has no leverage unless you add it.

Hedging a stock portfolio

Index futures let you reduce a portfolio’s market risk for a while without selling the stocks. The number of contracts to sell:

contracts = portfolio value × beta ÷ notional value of one contract

Beta measures how much the portfolio moves with the index: a beta of 1.2 means it tends to move 1.2% for each 1% the S&P 500 moves.

Example: a $150,000 portfolio with a beta of 1.2, S&P 500 futures at 6,000:

150,000 × 1.2 ÷ (6,000 × $50) = 180,000 ÷ 300,000 = 0.6 ES contracts

You cannot sell 0.6 of an ES, but you can sell 6 MES (each with $30,000 of notional): 6 × 30,000 = $180,000. If the market then falls 5%, the portfolio should lose about 6% ($9,000), and the 6 short MES gain 5% of $180,000 = $9,000.

A hedge removes market risk, not the risk of the particular stocks you own, and it also removes the market’s gains while it is in place. Remove it when the reason for it has passed.

Practical habits for index futures

• Know your contract and its tick value before the session. Write it at the top of your plan: “MES: $1.25 a tick, $5 a point.”
• Mark the overnight high and low, the previous day’s high, low and settlement, and the levels from your boxes.
• Plan around 8:30 a.m. and 10:00 a.m. reports and the 9:30 a.m. stock open.
• Watch the roll. In the week before quarterly expiration, make sure you are trading the contract with the volume.