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The Ultimate Trading Vehicle
by Tom Busby
DTI President/Trader
www.DTITrader.com
I have been trading the financial markets, including stocks, bonds, commodities, options, and the futures markets, for more than 25 years. Through my experiences in the market, most notably the crash of 1987, I have learned many valuable lessons about each of these trading vehicles. First lesson: options are NOT the great trading vehicle that I once thought they were. Second lesson: overnight risk is the real culprit in trading the stock market. Third lesson: if I was going to have success in the stock market, I had to learn to make money on both sides of the market.
In 1982 I discovered the "ultimate trading vehicle" while reading an article in the Wall Street Journal about the birth of the S&P 500 Futures market. I learned that the S&P would allow me to play both sides of the market while constantly monitoring my risk. The S&P 500 and the newer E-mini S&P are futures contracts traded at the Chicago Mercantile Exchange. They offer several attractive features needed for trading: liquidity, volatility, accessibility, leverage, and risk management.
Trading a combined average of 400,000 contracts every day, the S&P and E-mini futures contracts offer an ease of entry and exit that is unlike any other markets. Yesterday, I watched a stock trader wait 25 minutes to get filled on a limit order for 1,000 shares of stock. I mentioned to her that if I were trading the equivalent to her 1,000 shares of stock, 4 SP contracts at $250/point or 20 E-mini's at $50/point, I could get filled in a matter of minutes due to the liquidity. Also, with an average daily trading range of 16-17 points, the S&P 500 futures offer the daily volatility needed to capitalize on intra-day movements.
Opportunities exist to take both long and short positions throughout most trading days, which gives a trader more opportunities to profit. Even the most volatile stocks in today's market typically do not move more than 3 to 5 points in a day, so you have to be both precise in your analysis and timely in your execution in order to profit from such a narrow trading range.
Moving on to accessibility, the S&P 500 futures trade 24 hours a day from Sunday evening at 5:30pm CDT until Friday afternoon at 3:15pm CDT. I have developed a trade called the "Early Bird" trade that takes advantage of the nightly movement, typically 6 to 7 points, on the S&P futures. While I need sleep, food, and time with my family, I also need to trade when the odds are in my favor. If that involves getting up a little early then, I'm happy to do so.
In terms of leverage, you can control approximately $250,000 worth of stock with a margin requirement that is typically only 2 to 3%. While day trading margins for the S&P vary from broker to broker, you can typically control one S&P contract with a deposit of $10,000, or one E-mini contract for $2,000. Let's look at an example to see how the E-mini capital requirements are significantly lower that the requirements needed to control the same amount of the SPDRS (index-traded stock that is designed to trade at roughly 1/10 the level of the S&P 500 Index). For example, if the S&P 500 is trading at 1025.00, then one E-mini S&P futures contract is valued at $51,250 ($50/point x 1025.00) and can be controlled with an initial margin requirement of $2,000. However, to control $51,250 worth of SPDRS, it would require 500 shares of stock ($51,250/102.50 share= 500 shares) and a margin of at least $25,000 (50% margin).
If you made $5,000 trading each of these markets, the rate of return on the S&P E-mini contracts would be 250%, while the rate of return on the SPDRS would only be 17%. The S&P 500 Futures also offer some tax advantages for traders, because 60% of gains are taxed as short-term gains, but 40% is taxed as regular income. For those trading equities, 100% of gains realized are taxed as short-term gains. An S&P 500 Futures trader who made $100,000 in a year would actually take home $5,000 more than a stock trader who made the same $100,000.
The final feature of the S&P 500 futures that sold me on its viability as a trading vehicle is the flexibility it gives to manage risk. It is easy to place stop-loss orders on the S&P to hedge every position a trader takes. This permits prudent risk management to contain losses to affordable levels in order to allow a trader to be wrong on a trade, but still preserve his or her trading capital.
Each of these features make the S&P 500 and E-mini S&P the ideal trading vehicles. Your odds of achieving success increase dramatically when you are provided ample liquidity, volatility, accessibility, leverage, and risk management. The S&P does not have to be the "risky market" if you know how to take advantage of these characteristics and trade when the odds are in your favor.
Over the last 20 years of trading the S&P, I have developed a proprietary method of trading called the Roadmap methodology. Combining time of day, key numbers, and proprietary software that tracks key market indicators, this method is a conservative approach to trading that only puts me in the market when all of the odds are in the my favor. EVEN IF YOU NEVER PLAN TO TRADE the S&P 500 Futures market, it has such a powerful influence on the global economy that you CANNOT AFFORD to NOT educate yourself about the impact that it has on your success in the markets.
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