Last week, TheoTrade co-founder, Don Kaufman, unveiled his Ultima Income Generator class that incorporates micro S&P 500 Index futures options for small accounts. The class generated huge interest from our current members and many people joined the TheoTrade ranks to participate in the two-day discussion of how to sell premium and hedge.
One of the big takeaways from the class is the huge opportunities for small account holders to trade this style of trading. The concept of being a premium seller has often times courted the ranks of traders with large accounts and traders with around $2000 to $5000 ended up being option buyers. This past year has been the year of the smaller trader and the accessibility to more advanced strategies has now opened up for the masses.
Oh, and if you missed the webinar, you can watch the Ultima Income Generator replay.
Trading Revolution
When did this change? It happened with the introduction of micro index futures and then with addition of micro futures options. The ability to use SPAN (specialized portfolio analysis of risk) margin and the smaller contract size of the micros gives small accounts huge opportunities if they know how to capitalize on it.
The first step to taking the reigns of this opportunity is to understand the basics of futures options. This post to help provide a foundation to begin to use micro futures options in your trading.
What are S&P 500 Futures Contracts?
As you might guess, the S&P 500 futures track the S&P 500. However, that’s not exactly all you need to know.
The first thing you need to know about futures is that it is a derivative contract that represents the obligation to buy or sell the index. That is a little different from an option contract where one party has the right and the other party carries the obligation. For futures, the buyer and seller carry the obligation.
A big difference between futures on an index versus futures on a commodity is that there is no physical delivery. I guess they could round up shares of the S&P 500 that totaled the contract value and ship it by UPS to your door, but that would be a logistical nightmare. Instead, these types of products are settled in cash. At the contract’s expiration, the buyer or seller will either pay any losses or receive the profits from the contract.
S&P 500 Futures Contract Size
The futures contracts on the S&P 500 come in three different sizes: full, mini, and micro. Understanding the contract size is an important step in learnings to trade these products or options on the products.
Full Size Contract
A full-size standard S&P 500 futures contract has a value that is $250 times the S&P 500 level at the time the trade is entered. With the S&P 500 Index at 3815, that means the market value of the contract is $953,750. Margin requirements don’t force you to have that amount in your account, but a full-size contract requires considerable funds to reasonably trade them and has huge steps as you from one to two contracts.
Mini Contract
Until the last year, the only other option was to trade mini contracts. It was a step in the right direction but didn’t lend itself to traders to learn to trade them without significant risk. The value of a mini contract is one-fifth the size of full. Another differentiator with the full contract is that it is electronically traded, thus “E-mini.”
Calculating the contract value is similar to that of a full-size contract. In this case it’s just $50 times the S&P 500 value. With the S&P 500 at 3815, that means that value of the contract is $190,750.
We’re certainly moving in the right direction for retail traders, but still didn’t quite go far enough.
Micro Contact
Finally, on March 11, 2019 Micro Index futures were introduced. The contract size of the micros is one-tenth the size of a E-mini contract. With the S&P 500 at 3815, that means the value of the contract is $19,075. We’re not talking about money for take-out but we’re getting closer. However, with the lower contract value and margin, it makes it viable for smaller accounts.
Micro S&P Futures Tick Value
Once you understand the contract size of a micro S&P 500 Index futures contract, the next step is understanding how the price changes and how it will impact your profit and loss. The “tick size” represents the minimum price fluctuation and is set by the exchange.
For a micro contract on the S&P, the tick value is 0.25 index points, which has a tick value of $1.25. That means for every 0.25 index point change, the value of the micro contract will change by $1.25. That is certainly manageable for most any size account.
Micro E-mini S&P 500 Futures Trading Hours
The trading hours for the micro contract is very expansive but doesn’t yield around-the-clock liquidity. The current hours are Sunday through Friday from 5:00pm to 4:00pm CT. There is also a trading halt from 3:15pm to 3:30pm CT and a daily maintenance period from 4:00pm to 5:00pm CT. Apart from the maintenance periods and the halt, the trading is nearly 24/5. However, the liquidity of the market diminishes substantially outside of normal market hours.
Here is an image of the contract specs for all the micro futures contracts on the CME.
Micro S&P 500 Expirations
As you may have noticed in the above specs, the micro E-mini S&P 500 futures offer five different expirations. The contract months are the last month of each quarter in March, June, September, and December. That means that the current offering includes March of 2021 and March of 2022 as seen below taken from the thinkorswim platform.
Micro E-mini S&P 500 Futures Options
Now you have a foundational understanding of futures and specifically micro futures, let’s talk options on the micro futures contracts.
Futures Option Expirations
The first thing to understand is that each options expiration is tied to a specific contract. For example, here is a snapshot taken from the TastyWorks platform.
You may notice that the available option expirations go from two to 107 days to expiration. That means that the options are only tied to the March 2021 (/MESH1) and the June 2021 (/MESM1) futures contracts.
This is an important point to be made about futures options, they are tied to a specific futures contract. This can get more harrowing if you’re talking oil futures since the term structure of the futures market can be so different. However, for index futures the contract prices for the various expirations aren’t all that different.
Futures Option Contract Specifications
The next thing to know about futures options is how it will relate to the futures contract from a pricing standpoint. Of course, the general understanding of the movement in the underlying, time and volatility are similar, there are some key differences.
Tick Size
Just like futures, there is a tick value for options on futures. For example, micro E-mini S&P options have a tick size of 0.25 index points if its value is $5 or greater. Since the option has a $5 contract value, that means the value of a tick is $1.25. Here’s an image from the CME Group that illustrates this point.
When the value is less than $5, the tick size drops to 0.05, which means a tick value of $0.25.
Contract Size
Contract size is an area that will confuse many that are coming from an equity and index option background. Unlike those contracts, futures are not priced in 100 share increments. If you recall, the micro E-mini S&P contract is only five times the index. As a result, the options contract is only five times the option price.
For example, if you were to sell a put on the May monthly contract at the $3270 strike price for $47.50, you’ll receive a credit of $237.50. That credit is five times the price quoted for the bid on the option chain.
SPAN Margin
One of the most attractive aspects of trading futures and futures options is that you’re not restricted in the same way you are for equities, equity options and index options. That means no pattern day trader rule and the margin is much more favorable. This is a result of SPAN margin.
The incorporation of SPAN margin is derived from algorithms that determine margin requirements based on a global (total portfolio) assessment. This assessment is based on the one-day risk of an account. This means that the margin required is based on a calculation of the worst-possible one-day move in the asset. The risk scenarios that are fed into the system are influenced by price change, volatility and time to expiration.
The main point is that the margin required for futures options is significantly less than that of index or equity options. Because of the smaller contract sizes and lower margin requirements, it opens the world of premium selling to traders with accounts as little as $2000.
In fact, TastyWorks offers span margin if you apply for “The Works.” Also, TheoTrade has an agreement with TastyTrade to get three free months of TheoTrade for those that fund an account with at least $2000.
Conclusion
Hopefully, this introduction to futures and micro futures options will help you on your path to trading this product. The elimination of pattern day trader rules, smaller contracts and lower margin is a great combination for smaller retail traders and more experienced traders with larger accounts. The Ultima Income Generator class at TheoTrade covers both approaches as well as the necessary hedges to cover your assets.
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