A Brief Guide To Futures Contracts

This is a Guest Post by David Bergstrom, he is on twitter @dburgh he is the guy behind the Build Alpha software. He has spent many years researching, building, testing, and implementing market making and trading strategies for a high frequency trading firm, a handful of CTAs, individual clients, registered money managers, and even aspiring retail traders. His website is BuildAlpha.com.

Brief Guide To Futures Contracts

What is a Futures contract?

-A Futures contract is a financial contract that derives (derivatives) its price from an underlying asset. Futures contracts have an expiration date where the two parties (buyer and seller) agree to do business at a fixed price in advance.

-Most traders and speculators simply trade these contracts in the short-term as they would any other security. For instance, I can buy the S&P500 eMini futures contract today and sell it tomorrow and not have to worry about expiration.

-There are futures contracts for stock indexes, US treasuries, commodities, forex, agricultural products, oil, gold, etc.


Symbol and Expiration

-Futures contracts have different expirations. For example, the stock index futures expire quarterly in March, June, September, and December whereas Crude Oil futures expire monthly. Most traders trade the “front month” contract or the one nearest expiration as that is where the volume and liquidity tends to be. In late June of 2017 we would trade the S&P500 eMini futures contract that expires in September 2017 as we are past the June expiration date. The exchange websites have all the exact details.

-Futures symbols can be thought of as 3 parts: The root, expiration month, and expiration year. So you may see ESU7 where ES is the root for S&P500 eMini futures contract, U is the symbol for September expiration, and 7 is for the expiration year of 2017. Each month has its own unique letter that are easily memorized after a few expiration cycles.

– For speculators/traders it is rare to hold a contract past expiration. If one chooses to do so, please consult the exchange rules for how settlement is handled!



Contract Value and Multiplier

The value of a futures contract is often much more than the traded price. For example, the S&P500 eMini futures contract has a contract multiplier of $50 per point. This means the actual value of the contract is 50 times the traded price. So if the S&P500 eMini Futures contract trades at 2400.00 then the actual value is $120,000.00 or 2400.00 * 50.00.


Initial Margin

In order to trade one contract you do not need to put up the entire value of the contract, but rather what is called the “Initial Margin”. The Initial Margin is set by the exchanges, but the S&P500 Futures contract is usually only between $4000 to $5000 dollars. So for $5000 dollars one can control a contract worth $120,000; this is called leverage. Please see full disclaimers to see the two-sided sword leverage presents.


Tick Size

Each futures contract has a minimum tick size. This is the minimum move a futures contract can move per trade. In stocks, the minimum tick size is a penny. The minimum move or tick size of the S&P500 eMini futures contract is 0.25 or ¼ of a point. We know that 1 point is equal to $50.00 (contract multiplier for this market) so each tick move of the S&P500 futures contract is worth $12.50 per contract as 12.50 is ¼ of the $50 point value.


Two sample trades.

Entry: Buy 1 contract S&P500 eMini Futures at 2432.50 ($5,000 margin)

Exit: Sell 1 contract S&P500 eMini Futures at 2438.75

Result: 2438.75 – 2432.50 = 6.25 points.

Money Made: 6.25 points * $50.00 contract multiplier = $312.50


Entry: Buy 2 Crude Oil Contract at 45.75 ($3000 margin * 2 contracts = $6000)

Exit:  Sell 2 Crude Oil Contract at 45.52

Result: 45.52 – 45.75 = -0.15

Money Made: -0.15 points * $1000.00 contract multiplier * 2 contracts = -$300.00


Benefits of Futures:

  1. No Pattern Day Trade Rule. Once you fund an account – usually $5,000 – you can trade with no limitations other than meeting the margin requirements for your desired contract.
  2. No requesting shares to short. You can always short futures contracts.
  3. Futures trade on globex hours or 23 hours and 5 days per week. This means rarely no gaps or news events when the markets are closed! Stops can be left in overnight – again stop market slippage applies to any traded security.
  4. Leverage. Again a two sided sword, but buying 500 $SPY shares trading at 243.50 will require (243.50 * 500 shares) about $121,000. You can control a similar sized position or similar amount of notional dollars for only $5,000 in the futures market.
  5. Tax benefits. The first 60% of your short-term trading gains on futures contracts are actually taxed at long-term capital gains and the remaining 40% of your futures trading gains are taxed as normal income. 100% of your short-term stock trading gains are taxed as normal income or as much as 20% higher than the long-term capital gains rate! Additionally, futures do not require you to list every single trade on your taxes like stocks and ETFs do, but rather a simple line stating how much you earned or lost – verify with your account or a tax professional!

Tax example:

Trader A: Earns $100,000 trading stocks and is in the 25% tax bracket.

Tax Bill: $100,000 * .25 = $25,000 owed to US Government


Trader B: Earns $100,000 trading futures and is in the 25% tax bracket.

Tax Bill: ($100,000 * .6 * .15) + ($100,000 * .4 * .25) = $9,000 + $10,000 = $19,000


Trader B: Saves $6,000 in taxes and can now afford the margin for another S&P500 futures contract strictly from his tax savings alone.

Dave is the founder of Build Alpha software. Build Alpha is software that automatically creates systematic trading and investing strategies for stocks, futures, forex, and ETFS. Build Alpha allows the validation and stress testing of each strategy, and generates exportable and executable code for each strategy for a handful of popular brokers – all done with no programming necessary.

Dave can be reached at [email protected] or found on twitter @dburgh