Futures Education

Long Index Futures

The primary objective of the long index futures trade is to identify an index that is trending higher and buy the index's mini index futures. Once the index has reached a peak or resistance point, you offset the position by selling the contract back to the market.
Let's work through the mechanics of a long index trade.
You've done your homework and analyzed the trends on the Dow Jones Industrial Average. According to your analysis, the index has broken out of a double bottom and is starting an upward trend that you believe will move up 200 points before hitting the first reversal.
You look up the contract specifications for the Dow Jones Index futures and find out the initial margin requirements are $13,750. Recognizing this would leverage too much of your available cash, you turn to the mini-sized Dow futures contract specifications and find the initial margin requirement is $4,000.
The next thing you want to know is the tick size and the value of each tick. Again from the contract specification on the mini-sized Dow futures, you see that a tick is 1 point on the index and it is worth $5.00. This means that if the index goes up 50 points in a day, the value of that move is $250 (50 ticks * $5.)
You decide to go ahead and purchase the mini Dow futures. You place a limit order to buy 1 contract when the futures price is 11,200. Since the Dow futures are currently trading for 11,225, you may not get filled, so you may want to consider placing a market order to buy at the next available price. After looking at an intraday price chart on the Dow, you notice the market has been trading in a range between 11,200 and 11,250 for the past 3 days, so you decide to leave your limit price of 11,200.

A Couple of Hours Later

You get an email notification letting you know that you have just purchased 1 mini-sized Dow futures contract at a price of 11,200. You are now long 1 mini-sized Dow futures contract and want to protect yourself against downward price movement, so you place a stop loss order at 11,150. This way if the market drops below 11,150 your position will be offset or closed and you would suffer a 50 point or $250 loss.

The Next Couple of Days

The next couple of days of trading are touch-and-go, with the Dow dropping down into the 11,170 price range a couple of times. However, you don't let this trouble you too much. You still believe the market is poised to move higher. You have a plan and you're sticking to it.

The Third Day

The third day brings some good news! The Dow broke out above 11,250 and is moving higher - in fact, at the close it is trading right at 11,300. You are quite excited and think about selling to book your profit of 100 points or $500. You decide to keep holding onto your position; after all, your analysis was a 200-point move.

The Fourth Day

The fourth day was a complete disaster. The market dropped back down to 11,225 and you lost 75 points or $375. Frustrated and confused you seriously think about selling out now, before you lose any more. After all, there is a saying in the market that you can never go broke selling at a profit! But you have a plan and you decide to stick to it.

The Fifth Day

The fifth day finds the market back up at 11,300. You are excited again. The market has given you another opportunity to book your 100-point or $500 profit. You are seriously contemplating selling when you remember what your futures training course taught you: plan your trade and trade your plan. To console yourself, you raise your stop to 11,250. This way if the market drops again you will still get out for a profit and decide to let your trade play out a few more days.

The Sixth Day

On the sixth day you are glad you had the strength to stay in the market. The Dow goes up 75 points to 11,375 and your total gains are now 175 points or $875! Being smart, you decide to place a sell limit order for 11,400, just in case the market hits it while you are not looking.

The Seventh Day

On the seventh day you get an order confirmation that you have sold 1 mini-sized Dow futures contract for 11,400. You bought the mini-sized Dow index for 11,200 and sold it for 11,400, booking 200 points or $1,000 in profit! That is a 25% return on your initial investment of $4,000.
In all the euphoria of the moment, something keeps nagging you about the trade. All of a sudden in the middle of the night you remember what it is - you forgot to close your stop loss order. This means that you still have an active order to sell 1 mini-sized Dow futures contract at 11,250. Immediately you jump out of bed and rush over to the computer and cancel the stop order. You remember your futures training course reminding you to make sure you NEVER leave any order open that you don't want. It could be disastrous to wake up in the morning and discover you have a short position in the mini-sized Dow!

Short Index Futures

The primary objective of the short index futures trade is to identify an index that is trending lower and sell the index's mini index futures. Once the index has reached a valley or support point, you offset the position by buying the contract back.
Let's work through the mechanics of a short index trade.
The Feds are expected to announce an interest rate increase of 25 basis points, which is supposed to curb inflationary pressure in the economy. The market has been trading at all-time highs for several weeks, and stocks are trading at high multiples. You expect that the rate decision by the Fed will be the catalyst to start a pullback to an intermediate support level on the S&P 500 index at 1050. The S&P is currently trading at 1128.
You understand the risks of such a setup, and you determine that you are willing to risk no more than $500 on this setup.
The first thing you do is check the contract specifications for the S&P 500 index futures. The initial margin requirement is currently $30,000 on the standard contracts. You also check the e-mini S&P futures and discover the initial margin requirement is $6,000. You decide to use the e-mini S&P 500 futures contract.
Next you check the tick size and value. The minimum fluctuation on the e-mini S&P 500 index is $0.25, which is equal to $12.50. A move of one E-mini S&P 500 futures index point is the equivalent of four ticks and would equal $50.
You decide to initiate a short in the e-mini S&P 500 index to profit from the expected downward movement. You log into your computer and enter an order to sell 1 e-mini S&P 500 index future at the current market price. Immediately you receive a confirmation that your order has been executed and you are short 1 e-mini S&P 500 index future at a price of 1128.75.
You are really concerned about risking too much money on this trade and want to make sure you do not lose more than $500. Knowing that you should use stops on every trade you make, you decide to use a buy stop order. Remember, to offset a short position you must buy a futures contract. Since there are 4 ticks per point and each tick is worth $12.50, you determine that your buy stop must be no larger than 10 index points away (10 points * 4 ticks per point * $12.50 per tick = your $500 maximum loss). You go to your computer and enter a "BUY STOP" order at 1138.75, which is 10 points away from your sell price.
You are pretty confident that if the Fed increases interest rates the S&P 500 index will drop to the 1050 point level over a 1-3 week period.
Two days later, the Fed announces a rate increase and the S&P drops 12 points. How much money did you make? Twelve index points is equal to 48 ticks (1 point equals 4 ticks) and 48 ticks are worth $600.
You are thrilled with the move and decide to follow the market with a trailing stop, so you change your buy stop order from 1138.75 to 1128.75 or your original sell price.
Over then next couple days the S&P continues to drop all the way down to 1072. You have trailed the index with buy stop that is 10 points away from the lowest point and it is currently set for 1082.
The next day is pretty volatile and you are concerned that buyers are starting to enter the market. While you are at work you get a trade confirmation that your buy stop order has been triggered and you bought 1 e-mini S&P 500 index futures at a price of 1082.
While the index did not do exactly as you had hoped, you are still thrilled with the trade. You had a plan to follow the market with a trailing buy stop to protect profits and limit upside risk. You had a target of 1050 which you did not reach, but you also had a contingency plan to protect profits and avoid loss, which was triggered.
You still made money on the trade. You initially sold the contract for 1128.75 and turned around and bought it back for 1082. The total gain on this short trade is 46 points and 3 ticks (1128.75 - 1082 = 46.75). That is a 187 total tick gain (46.75 points * 4 ticks per point = 187 ticks). Your total income on the trade is $2337.50, or a 38.9% return on investment!
Now that your short position is offset, or closed, by the trigger of your buy stop order, you carefully check for any open positions that you may have forgotten about. You don't find any, so now you can celebrate!