Hands down, the number one question that I am asked when speaking before groups, presenting the trading style we employ at my firm FuturesANIMAL, is "why do you trade the E-mini S&P 500 future when you can trade the SPDR S&P 500 ETF Trust (SPY)?" This is a fantastic question, and with its popularity as of late, it is leading me to believe that retail traders are becoming more and more interested in what futures have to offer as an addition to their investment portfolio.
In my opinion, there is no clear answer as the answer is ultimately dependent on your trading style. There are certainly advantages to both instruments, as I will outline below. However I would submit, as supported through a professional report that the CME Group (CME) published in September of 2012, that the advantages afforded by the E-mini S&P contract outweigh those of the SPY, and are at the very least something that the retail trader should educate themselves on. Now I preface this article with the fact that I still trade the SPY, and it remains an integral part of my equity portfolio. So I want you to understand that I am not writing this article claiming that futures are the end-all-be-all for trading indices, only that they provide distinct advantages that the retail trader should be aware of and ultimately consider.
E-mini S&P 500 Advantages
1. Liquidity - The CME Group noted in their 2012 report that the E-mini S&P contract traded, on average, $142 billion in transaction dollar volume per day versus a $18.5 billion that the SPY trades. Please note that this is not a huge selling point for the retail trader, as both are very liquid, but for larger orders, speed of transaction and less slippage, the E-mini provides a nice advantage.
2. Execution - E-mini's are traded nearly 24/7 during the weekdays on the CME Globex system, whereas the SPY is only traded during normal and extended US exchange trading hours (6am-8pm EST).
3. Leverage - In trading futures the margin requirements are different from those in the equity markets. The SPY, which is traded in the equity market and thus falls under equity market margin requirements, will be subject to Regulation T margin requirements (portfolio margin not assumed). This means one must place an initial 50% deposit down on the transaction, equating to a 2:1 leverage ratio. However, with the E-mini S&P the margin requirement is met via a performance bond that secures the transaction. For every contract, which has a nominal value of $88,000 assuming we purchase the contract at 1,760 ($50 x 1,760), the initial requirement is $4,510 (subject to adjustments). This equates to a deposit of 5.1% of the nominal value of the underlying. Therefore, it is apparent that E-mini's offer far more bang for the buck than the SPY, however also understand that with leverage can come both good and bad outcomes. While your returns can be enhanced via leverage, so too can your losses.
4. Tax Benefits - As always I urge you to consult with a tax professional as they can speak directly to your tax situation, for I am by no means a tax professional. With that said, for the short-term trader (less than 1 year) trading the E-mini might provide distinct tax advantages over the SPY as they are classified differently by the tax code. With the SPY you only initiate a taxable event when you liquidate your position, which will then incur a capital gains tax based on the time horizon of your holding. So for those whose time horizon on a trade is less than one year, your capital gains would be taxed at your personal income tax rate. In contrast, index futures fall under US tax code 1256 where gains and losses are marked to market at the end of every year. In this scenario time horizon is not a factor, as realized and un-realized capital gains/losses are lumped together, regardless of time held, with 60% of the gains are treated as long term and 40% as short term. So for those in higher tax brackets and trading frequently within a 1-year timeframe, the E-mini could present a tax advantage.
5. Commissions - Generally speaking, commissions on a futures trade are less when compared to a comparable trade in nominal dollar size in the SPY.
SPDR S&P 500 ETF Trust (SPY) Advantages:
1. Liquidity and Access - The SPY, regardless of the dollar volume shown above, remains an extremely liquid product that is easily accessible by most any retail-trading platform. Whereas some online brokers do not offer access to futures trading, the SPY serves as a nice alternative to the E-mini S&P.
2. Smaller Denominations - Unlike the E-mini, the SPY is priced in much smaller denominations (roughly $176.00 at the time of this writing), particularly attractive for those who are not as interested in controlling upwards to 500 shares of the fund, which is what the E-mini roughly equates to.
3. Easy to Comprehend - The trading of stocks has been around since everyone reading this article has been alive, and the concept is rather simple. With the SPY structured much like a stock, and traded in the same venue, it is no surprise that the retail trader has adopted this instrument with open arms, as the perceived learning curve is much less than the E-mini.
In conclusion, please note that the opinions that I put forth above are my own, and are merely expressed for the purpose of bringing clarity to a question that is becoming more common around retail trading circles. As I stated at the beginning, I do not believe that there is a clear-cut answer to the question, as every trader and their style is different. Thus different instruments will present different advantages. However, I do in fact believe that the next big push by the retail investor will be into the futures market, a direct result of main street comprehension around the distinct advantages that the trading of index futures presents.
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