Introduction To Micro Futures, With CME

What are Micro futures?

You could call futures a jack of all trades given that investors can use them to increase their exposure to different markets, manage their risk, and hedge their bets. When an investor enters into these financial agreements, they’re obligated to buy or sell a specified asset – be that a commodity, currency, or stock index – at a set price on a set date in the future. Therefore, an investor who expects oil prices to rise might buy West Texas Intermediate Oil (WTI) futures, hoping to sell them later for a profit. Likewise, an investor who thinks the U.S. technology sector is overpriced might sell Nasdaq-100 futures, believing they’ll buy them later at a lower price and pocket the difference.

But there’s a catch. Traditional futures have higher face values compared to micros, meaning you should consider the right size contract depending on your available capital. Micros let you trade a fraction of the standard futures contract size, so they’re a more affordable and manageable option than the full-sized versions. To get specific, Micro E-mini Equity Index futures – which track widely-followed indexes like the S&P 500, Nasdaq-100, Russell 2000, and Dow Jones Industrial Average – have a face value of just one-tenth of their standard futures counterparts. Put simply, they can be a more cost-effective way to manage risk and access the stock index markets.

Yet, with any investment, it’s always important to understand your market before trading. Let's explore how to make the most of Micro futures for stock indexes.

How do you trade Micro futures?

Understand their workings: Each micro future has what’s called a “fixed contract multiplier”, which allows us to calculate the face value per future. For example, if the E-mini Micro S&P 500 futures contract trades at 4,180 with a $5 multiplier, then its face value would be $20,900 per contract (futures contract price x multiplier = face value). Each micro future also has a minimum price fluctuation associated with it. This is known as a “tick”, and it specifies the minimum price movement for each future. Combine those two values, and traders should have all the information they need to understand the financial value of any futures contract.

Manage expiration: Every futures contract has an expiration date, and Micro E-mini futures expire quarterly. Traders have three main options to handle expiration dates, and their choice will depend on their own goals.

First, they could offset the position by executing an opposite and equal transaction before the contract expires. This way, they can assess the market and close out their position earlier than anticipated, with profit or loss determined by the difference between the initial and offset positions.

Second, traders can let the contract expire. Micro E-mini futures are settled in cash against the official opening price of the respective index on the expiration date – but because this means the trader has no control over the timing of the trade, they have to accept the final settlement price.

And third, they could roll the contract on, maintaining their exposure to the index by immediately extending the contract from one expiration date to the next. This involves trading out one expiring contract and entering a deferred contract.

Navigating expiration dates is a crucial part of managing your trading account effectively, and your best approach will hinge on your individual trading strategy.

How do you calculate your profit or loss?

Imagine you buy one Micro E-mini S&P 500 contract when the index is trading at 4,900 points. The face value of the contract would then be 4,900 points x $5 (contract multiplier) = $24,500.

The tick increments for the Micro E-mini S&P 500 are quoted in a quarter of one point (0.25 points). This means that a one-tick move in the Micro E-mini S&P 500 would equal $1.25 ($5 contract multiplier divided by four). And a one-point move, which consists of four ticks, is worth $5.

Let's say the index moves up by 12 ticks (three points) to hit 4,903 points. That makes the new face value of your position $24,515 (4,903 points x $5). But to calculate your profit, you’ll need to subtract the new face value of your position from the initial one: $24,515 - $24,500 = $15. (Or since each tick is worth $1.25, your profit from the 12 tick move would equal $1.25 x 12 = $15).

Losses are calculated in the same way as gains. You can see from this example that Micro E-mini Equity futures, like the S&P 500, can offer a smaller, more affordable way to access the world of liquid stock futures.

How do you manage risks with Micro futures?

When dealing with Micro futures, it's essential to have a solid plan to protect your capital and minimize losses. Here are some key ideas to consider:

Contract selection: Choose your Micro futures contract based on your risk tolerance, trading goals, and market knowledge. Focus on indexes you understand and are comfortable trading. This will help you make informed decisions and manage risks more effectively.

Number of contracts: To manage risk, limit the number of contracts you’re trading at any given time. Trading too many contracts can expose you to more risk than you can handle. Determine an appropriate position size based on your account size, risk tolerance, and trading strategy.

Set stop orders: Stop orders are a useful tool to limit potential losses. A stop order automatically closes your position if the market moves against you and reaches a predefined price level. By setting a stop order, you cap your potential loss and make sure that you don't hold onto a losing position for too long.

Counterparty risk: This is the risk that the other party in your futures contract might default on their obligations. To mitigate this risk, trade on reputable exchanges with robust financial safeguards. These exchanges act as a central counterparty, ensuring that both buyers and sellers meet their obligations.

Diversification: Don't put all your eggs in one basket. Diversify your portfolio by trading a mix of Micro futures contracts and other financial instruments. This way, you can spread your risk across different markets and assets, reducing the impact of a single trade on your overall performance.