equity index futures products - cfa institute · 2019. 5. 23. · in early april 2018 a portfolio...

© 2019 CME Group. All rights reserved.

Equity Index Futures ProductsRisk management and performance enhancement

Prepared for CFA Society VBA Netherlands

May 2019


Futures trading is not suitable for all investors, and involves the risk of loss. Futures are a leveraged investment, and because only a percentage of

a contract’s value is required to trade, it is possible to lose more than the amount of money deposited for a futures position. Therefore, traders

should only use funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one

trade because they cannot expect to profit on every trade. All references to options refer to options on futures.

Swaps trading is not suitable for all investors, involves the risk of loss and should only be undertaken by investors who are ECPs within the

meaning of section 1(a)12 of the Commodity Exchange Act. Swaps are a leveraged investment, and because only a percentage of a contract’s

value is required to trade, it is possible to lose more than the amount of money deposited for a swaps position. Therefore, traders should only use

funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one trade because

they cannot expect to profit on every trade.

Any research views expressed are those of the individual author and do not necessarily represent the views of the CME Group or its affiliates.

CME Group is a trademark of CME Group Inc. The Globe Logo, CME, Globex and Chicago Mercantile Exchange are trademarks of Chicago

Mercantile Exchange Inc. CBOT and the Chicago Board of Trade are trademarks of the Board of Trade of the City of Chicago, Inc. NYMEX, New

York Mercantile Exchange and ClearPort are registered trademarks of New York Mercantile Exchange, Inc. COMEX is a trademark of Commodity

Exchange, Inc. KCBOT, KCBT and Kansas City Board of Trade are trademarks of The Board of Trade of Kansas City, Missouri, Inc. All other

trademarks are the property of their respective owners.

The information within this presentation has been compiled by CME Group for general purposes only. CME Group assumes no responsibility for

any errors or omissions. Additionally, all examples in this presentation are hypothetical situations, used for explanation purposes only, and should

not be considered investment advice or the results of actual market experience.

All matters pertaining to rules and specifications herein are made subject to and are superseded by official Exchange rules. Current rules should be

consulted in all cases concerning contract specifications.

Copyright © 2019 CME Group. All rights reserved.

Disclaimer

© 2019 CME Group. All rights reserved. 3

Benchmarking


Benchmarks are indexes created to include multiple securities

representing some aspect of the total market.

Benchmark indexes have been created across all types of asset

classes.

In the equity market, the S&P 500 and Dow Jones Industrial average

are two of the most popular large cap stock benchmarks.

Source: Investopedia, www.Investopedia.com, November 2017

Benchmarks

http://www.investopedia.com/


Examples of World Equity Benchmarks

Equity Index Country Exchange

FTSE 100 United Kingdom NYSE Euronext

CAC 40 France NYSE Euronext

DAX Germany EUREX

Nikkei 225 Japan SGX, OSE, CME

Hang Seng Hong Kong HKEx

IPC Mexico MexDer

IBovespa Brazil BM&F, CME


World Equity Futures Volume

Equity Index Futures by Exchange

Source: WFE IOMA Report 2018, dated April 2019

0 100 200 300 400 500 600 700 800

B3 (Brazil)

CME Group

Eurex

Japan Exchange Group

Singapore Exchange

Moscow Exchange

HKEX

ICE Futures Europe

Korea Exchange

TAIFEX

Contracts traded in millions


World Equity Futures Volume

Equity Index Futures by Exchange

Source: WFE IOMA Report 2018, dated April 2019

0.0 10.0 20.0 30.0 40.0 50.0 60.0 70.0 80.0 90.0 100.0

CME Group

Eurex

Japan Exchange Group

HKEX

Korea Exchange

TAIFEX

ICE Futures Europe

Notional Value in trillions


S&P 500 (3) Nikkei 225 (2)

NASDAQ – 100 (3) E-mini S&P MidCap 400

DJIA (2) S&P 500 Total Return

Russell 2000 (2) Select Sectors (11)

Major Benchmark Indices include:

Equity Futures Equity Options

The CME Group Index Suite

Futures on globally recognized equity index benchmarks


Liquidity Comparison

2018 ADV of E-mini S&P 500 (ES) futures in notional terms:

$241.1 Billion average per day.

E-mini S&P 500 futures greater than cash market and

significantly greater than the ETF market in the U.S.

0

50

100

150

200

250

300

ES Cash ETFs

Ave

rage

Dai

ly V

olu

me

(USD

Bill

ion

s)


Multiple uses and users

CFTC COT Report:

Breaks Open Interest

data in reporting

categories:

1. Dealer / Intermediary

2. Asset Manager / Institutional

3. Leveraged Funds

4. Other Reportable

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

Dealer/Int AM/Instit Leveraged Funds Other Reportable Non-Reportable

Contracts Open

E-mini S&P 500 Futures

Long

Short

Spread

Source:CFTC COT Report Dated April 16, 2019


Mechanics

E-mini S&P 500 pricing (25 April 2019)…

Futures Contract

Value=

Contract

Multiplierx Quoted Value

= $50 x 2926.25

= $146,312.50

The dollar value of 1 contract ($146,312.50) is the contact’s

Notional Value (NV). NV changes with index price moves.

Month Year Settlement Estimated Volume Open Interest

JUN 19 2926.25 1,346,119 2,618,456

SEP 19 2932.00 1,193 36,105

DEC 19 2937.00 73 6,661

MAR 20 2943.00 1 3,744

JUN 20 2947.50 0 2

TOTAL 1,347,386 2,664,968


1. Volume & Open Interest tend to stay in front quarterly contract month.

2. Small percentage of OI goes to expiry.

Mechanics



JUN 19 2926.25 1,346,119 2,618,456

SEP 19 2932.00 1,193 36,105

DEC 19 2937.00 73 6,661

MAR 20 2943.00 1 3,744

JUN 20 2947.50 0 2

TOTAL 1,347,386 2,664,968


Mechanics


Futures at higher levels in deferred months reflecting negative carry as

dividend earnings are now lower than financing costs.


JUN 19 2926.25 1,346,119 2,618,456

SEP 19 2932.00 1,193 36,105

DEC 19 2937.00 73 6,661

MAR 20 2943.00 1 3,744

JUN 20 2947.50 0 2

TOTAL 1,347,386 2,664,968


Mechanics

Futures

Price=

Spot

Index

Value

+Finance

Charges- Dividends

Futures contract pricing

This difference reflects the expected premium or discount at which

futures are expected to trade relative to the spot index value.


Mechanics

-60

-40

-20

0

20

40

60

t+0 t+1 t+2 t+3 t+4 t+5 t+6 t+7

Positive Carry

Negative Carry

Cost of Carry …

If dividend stream < finance

costs ➔ negative carry

• Futures at higher levels in

deferred months … reflecting

costs incurred carrying stock

portfolio

If dividend stream > finance

costs ➔ positive carry

• Futures at lower levels in

deferred months … reflecting

dividend earnings carrying

stock portfolio


The relationship between

short-term interest rates

and dividends dictate

whether positive or

negative carry prevails.

Mechanics

Dividend Yields vs. Short-Term Rates

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

2012 2013 2014 2015 2016 2017 2018 2019

Percent

S&P 500 Dividend 3-month LIBOR


Convergence to spot

Cash settlement to the SOQ of the physical index ensures full

convergence of futures to spot.

Futures exhibit a high degree of price correlation to spot.

E-mini S&P 500 Futures (ESM9) vs. Spot Index (SPX)

2450

2500

2550

2600

2650

2700

2750

2800

2850

2900

2950

ESM9 SPX


Beta Replication / Portable Alpha StrategiesPractical Applications

Index futures provide Beta or “benchmark” exposure without the need

for replication via cash equity securities:

• Frees up cash for redemptions or distributions because of futures

margining policies

• Presents a viable alternative for cash inflows from new

contributions

• Removes the human and technology requirement for index/portfolio

maintenance (costs)


Beta adjustment and hedging

Equity Portfolio Partially HedgedFully Hedged

+

-

Equity Values Decline

Index Value

Pro

fit

/ L

oss

Equity Values Advance

Selling futures against

the stock portfolio

reduces risk exposure

as a function of the

portfolio’s Beta.

Hedging with futures

allows for ease of

incepting and

unwinding hedge,

without the

transactional burden of

liquidating and

reinitiating physical

stock positions.


Case study #1

Simple beta adjustment

In early April 2018 a portfolio manager (PM) of a $100 million

portfolio anticipates a US equity market rally as a result of positive

earning reports.

April 13, E-mini S&P 500 (June) futures are at 2657.25 (ESM8).

The PM wants to extend her portfolio’s beta versus S&P 500 index

from a defensive .90 to a more aggressive 1.10, can she do this

using E-mini S&P 500 futures?

Hedge Ratio (HR) = (βtarget – βcurrent) x (Valueportfolio÷ Valuefutures)


Hedge Ratio (HR) = (βtarget – βcurrent) x (Valueportfolio÷ Valuefutures)

HR = (1.10 – 0.90) x [100mm / (2657.25 x 50)]

HR = (0.20) x ($100,000,000 / $132,862.50)

HR = 0.20 x 752.66

HR = 150.53 or buy 151 ESM8 to increase beta

Case study #1



On June 14, 2018 ESM8 = 2783.25, assume our PM unwinds adjustment.

ESM8 is 2783.25, up 126.00 index points or +4.7%.

Bought 151 = ESM8 = 2657.25

Sold 151 ESM8 = 2783.25

126.0 points x $50 per point x 151 contracts = $951,300 gain

Broad market rally (S&P 500) +4.8

0.90 beta weighted return = +4.3% or $4,300,000

$4,300,000 + 951,300 = $5,251,300 total return, or 5.2%

Outperforming the portfolio by 90 bps.

Outperforming the S&P 500 by 40 bps.

Case study #1


HR = 151 or buy 151 ESM8 to increase beta


Beta Replication & Portable Alpha Strategies

Overlay Strategies

e.g. tactical asset allocation

Absolute Return

e.g. hedge funds, CTA’s, real estate

Traditional Asset Mgmt

e.g. active small cap

Passive Indexing

e.g. index mutual fund


Equity Index Futures Sector Rotation

May 2019


Business Cycle and Sector Investing


The S&P 500 Index is made

up of 11 industry sectors:

Energy Materials

Industrials Consumer Staples

Info Tech Financials

Utilities Communications

Health Care Consumer Discretionary

Real Estate

All 500 stocks in the index fall into a sector.


Select Sectors: Weighting Distribution

Source: S&P Dow Jones Indices, January 31, 2019


Asset managers routinely trade and rebalance

between specific sectors.

Over-weight and under-weight sector strategies are

employed to reduce risk, capture alpha, or for

tactical market timing.


Select Sectors

Settlement prices for June 2019 contracts

On 25 April 2019

CME Select Sector

Index futures include

11 sectors

Select Sector Index

futures encompass

all 500 constituents in

the S&P 500 Index

Sector Name Symbol Multiplier Price

Notional

Value

Financial XAF $250 338.15 $84,538

Health Care XAV $100 885.80 $88,580

Materials XAB $100 598.40 $59,840

Industrial XAI $100 772.60 $77,260

Energy XAE $100 675.30 $67,530

Consumer Staples XAP $100 567.10 $56,710

Utilities XAU $100 584.40 $58,440

Technology XAK $100 793.40 $79,340

Con. Discretionary XAY $100 1209.90 $120,990

Real Estate XAR $250 172.70 $43,175

Communications XAZ $250 264.00 $66,000


Recent market data suggests market participants are

making increasing usage of listed products that enable

U.S. equity sector-based investing and trading.

“This could be in support of an active position elsewhere

in the portfolio (hedging a concentrated position in a

single name with an opposite position in the relevant

sector, for example.”S&P Dow Jones Indices, “Sector Effects in the S&P 500,” March 2019

Select Sector futures can be used in a spread trading

strategy to gain from the relative value performance of

one sector versus another.


Select Sectors: Rotation Strategy

March 2018: Tail-end of a volatile 1Q18 portfolio manager of $1.0

billion U.S. equity portfolio benchmarked to S&P 500 Index wants to

rotate to a more defensive portfolio. She decides a 5% rotation

from higher beta Financials into lower beta Utilities would be

appropriate.

March 9, she elects to make this adjustment using Select Sector

futures. She will sell Select Sector Financial futures and buy Select

Sector Utility futures.

How does she do this?



Adjustment value (AV) = 5% of total value = $1 billion x 5% = $50mm.

Hedge Ratio (HR) = AV ÷ Notional Value (NV) Sector futures

HRUtilities = 50,000,000 ÷ (492.70 x 100) = Buy 1,015 XAU contracts

HRFinancials = 50,000,000 ÷ (366.35 x 250) = Sell 546 XAF contracts

Buying 1,015 contracts of Utilities and selling 546 contracts of

Financial she has effectively rotated the portfolio away from financials

and toward utilities without changing the physical portfolio.


April 2, our PM reevaluates and decides to exit the rotation executing

offsetting trades, selling the Utility Sector Futures and buying

Financial Sector futures.

Sector/Index Mar 9 Apr 2 Change % Change

S&P 500 2786.57 2581.88 -204.69 -7.3%

Financials (XAF) 366.35 333.45 -32.90 -9.0%

Utilities (XAU) 492.70 503.60 +10.90 +2.2%

Sector Rotation Results

Data Source: Bloomberg



Futures Performance

Contract Position Points Multiplier P&L

XAF -546 -32.90 $250 $4,490,850

XAU +1,015 +10.90 $100 $1,106,350

Net $5,597,200

During the time considered, the S&P 500 index fell 7.3%, while

Financials Select Sector (XAF) futures fell by 9.0%, and Utilities Select

Sector (XAU) rose by 2.2%.

The Select Sector rotation made approximately $5.6 million, which

helps offset the core portfolio loss of $73 million (-7.3% of $1 billion),

resulting in a loss of $67.4 million.

The rotation strategy generated 56 basis points of alpha.



Spread positions generally reflect lower market risk and therefore

require lower margin requirements.

Bought 1,015 Utilities (XAU) and sold 546 Financials (XAF).

What is the margin required?

Margin delta side percent MM

XAF 1 A 20% $3,700

XAF 1 B $1,450

546 contracts as a 1:1 spread

XAF = 546 x 3700 = 2,020,200

XAU = 546 x 1450 = 791,700

add together = 2,811,700 - 20% = 2,249,360 plus remaining

469 XAU x 1450 = 680,050

2,249,360 + 680,050 = $2,929,410 margin required as spread

Outright legs = $3,491,950.



Select Sectors: Growth in Select Sectors trading and liquidity

0

500000

1000000

1500000

2000000

2500000

3000000

3500000

0

50000

100000

150000

200000

250000

300000

3-m

o A

ve O

I

3-m

o A

ve A

DV

Ave 3-mo ADV Ave 3-mo OI

Combined E-mini Select Sector Futures


Additional Resources

“Enhancing Equity Index Portfolio Returns Using Select Sector Futures”CME Group, January 2017• https://www.cmegroup.com/education/files/equities-sector-rotation-case-study.pdf

“Sector Effects in the S&P 500® The Role of Sectors in Risk, Pricing, and Active Returns”S&P Dow Jones Indices, March 2019• https://us.spindices.com/resource-center/thought-leadership/research/

“Enhancing Equity Index Portfolio Returns Using Select Sector Futures”CME Group, August 2018• https://www.cmegroup.com/education/articles-and-reports/enhancing-equity-index-portfolio-

returns-using-select-sector-futures.html

“U.S. Equity Index Futures for the Australian Asset Manager”CME Group, March 2019• https://www.cmegroup.com/education/articles-and-reports/us-equity-index-futures-for-the-

australian-asset-manager.html

https://www.cmegroup.com/education/files/equities-sector-rotation-case-study.pdf

https://us.spindices.com/resource-center/thought-leadership/research/

https://www.cmegroup.com/education/articles-and-reports/enhancing-equity-index-portfolio-returns-using-select-sector-futures.html

https://www.cmegroup.com/education/articles-and-reports/us-equity-index-futures-for-the-australian-asset-manager.html


Contact :

David Gibbs, Director

Market Development & Education

+1 312 207 2591

[email protected]

cmegroup.com

Connect with me on Linked-In

equity index futures products - cfa institute · 2019. 5. 23. · in early april 2018 a portfolio...

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