CME Group E-Mini S&P Options (
ES1!) and Micro S&P Futures (
MES1!), #microfutures
On July 30th, the Federal Open Market Committee (FOMC) decided to keep the Fed Funds rate unchanged at the 4.25-4.50% target range. Investors now turn their focus on whether the Fed will cut rates on the September 16th-17th FOMC meeting.
According to CME FedWatch Tool, as of August 6th, there is a 92.4% chance that the Fed will cut rates by 25 bps in September. My observation:
• Before July FOMC, market consensus was no rate cut, with the odds at 95.3% as of July 20th. Investors now overwhelmingly expect rate cuts to come at the next meeting.
• Two Fed governors broke the long-run consent and voted against the FOMC decision.
Today, I would like to explore two trading strategies focusing on the next Fed decision.
We will start by breaking down all possible Fed decisions as follows:
1) Cut rates by 25 basis points (92.4%)
2) No rate cuts (7.6%)
3) All others, such as cutting by 50 bps and raising rates by 25 bps (0%)
If we deem the 3rd option to be statistically insignificant, we now have an event with binary outcomes, namely, Cut and No Cut.
Since “Cut” is the market consensus, we will translate the possible outcomes as:
• Meet market expectations (Cut Rates)
• Exceed market expectations (No Cut)
Furthermore, financial markets will likely react calmly if the Fed decision meets expectations, while asset prices could swing widely if the FOMC exceeds expectations.
Typically, US stock market indexes, interest rate contracts and the US dollar exchange rates are very sensitive to the Fed decisions. Our discussion today will focus on stock indexes. I will follow up on the other two asset classes in future writings.
Based on the above analytical framework, we could design two sets of trading strategies:
Sell Call Options if a trader expects the Fed to cut rates
• Since the decision meets expectations, asset prices would not move a lot.
• Options may expire worthiness, which allows sellers to pocket the premium as profit.
Sell Futures if a trader expects No Cut
• Since the decision exceeds expectations, S&P prices could go down sharply.
• With build-in leverage in futures contracts, a trader could realize enhanced profit.
Now, let’s explore how to structure trading strategies using S&P futures and options.
Hypothetical Fed Decision 1: Meet Expectations
Cutting rates is bullish for S&P as it will lower borrowing costs for component companies. However, since market already priced in a Fed cut, stock prices will not move a lot.
If a trader shares this view, he could explore selling Out-of-the-Money (OTM) Call Options on CME E-Mini S&P 500 futures (
ES).
Each ES contract has a notional value of $50 x S&P 500 Index. On August 6th, the September ES contract (ESU5) is quoted at 6,341, making the notional value at $317,050.
• Call options at the 6500-strike are quoted at $42. By selling 1 call, options seller will receive $2,100 in upfront premium (= 42 x 50).
• Options expire on September 19th, two days after the FOMC. If ESU5 price does not exceed 6500, options seller will pocket the premium as profit.
• Warnings: selling options involves significant risks. Seller could lose more than the premium he collected. To cut losses, seller could buy back at the open market and exit the position. This will avoid losses to accumulate by expiration date.
Hypothetical Fed Decision 2: Exceed Expectations
Since rate cut is already priced in, an Unchanged decision will likely cause the S&P to fall sharply, as expected future borrowing costs will go up.
If a trader shares this view, he could explore selling CME Micro S&P 500 futures (MMES).
Each MES contract has a notional value of $5 x S&P 500 Index. On August 6th, the notional value of ESU5 is $31,705. Buying or selling 1 futures contract requires an upfront margin deposit of $2,135 at the time of this writing.
Micro S&P 500 futures are 1/10 in notional comparing to its E-Mini counterpart. With smaller size and lower margin requirement, the micro contracts are more approachable for non-professional traders. At the same time, they also enjoy the leverage built-in the futures contracts. Micro S&P contracts tap into the liquidity pool with the broad S&P contract suite.
Hypothetical Trade
• Short 1MESU5 at 6,341, and set a stop loss at 6450
• Trader pays $2,135 for initial margin
A “Meet” Scenario: S&P go up 1.5% to 6,436
• Short position loss: $475 (= (6436-6341) x 5)
• The maximum loss will be $545 if the S&P moves higher, due to the stop-loss feature
An “Exceed” Scenario: S&P falls 5% to 6,024
• Short position gain: $1,585 (= (6341-6024) x 5)
• The theoretical return is 74.2% (= 1585/2135), excluding transaction fees
Happy Trading.
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trading set-ups and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme/
ES1!) and Micro S&P Futures (MES1!), #microfuturesOn July 30th, the Federal Open Market Committee (FOMC) decided to keep the Fed Funds rate unchanged at the 4.25-4.50% target range. Investors now turn their focus on whether the Fed will cut rates on the September 16th-17th FOMC meeting.
According to CME FedWatch Tool, as of August 6th, there is a 92.4% chance that the Fed will cut rates by 25 bps in September. My observation:
• Before July FOMC, market consensus was no rate cut, with the odds at 95.3% as of July 20th. Investors now overwhelmingly expect rate cuts to come at the next meeting.
• Two Fed governors broke the long-run consent and voted against the FOMC decision.
Today, I would like to explore two trading strategies focusing on the next Fed decision.
We will start by breaking down all possible Fed decisions as follows:
1) Cut rates by 25 basis points (92.4%)
2) No rate cuts (7.6%)
3) All others, such as cutting by 50 bps and raising rates by 25 bps (0%)
If we deem the 3rd option to be statistically insignificant, we now have an event with binary outcomes, namely, Cut and No Cut.
Since “Cut” is the market consensus, we will translate the possible outcomes as:
• Meet market expectations (Cut Rates)
• Exceed market expectations (No Cut)
Furthermore, financial markets will likely react calmly if the Fed decision meets expectations, while asset prices could swing widely if the FOMC exceeds expectations.
Typically, US stock market indexes, interest rate contracts and the US dollar exchange rates are very sensitive to the Fed decisions. Our discussion today will focus on stock indexes. I will follow up on the other two asset classes in future writings.
Based on the above analytical framework, we could design two sets of trading strategies:
Sell Call Options if a trader expects the Fed to cut rates
• Since the decision meets expectations, asset prices would not move a lot.
• Options may expire worthiness, which allows sellers to pocket the premium as profit.
Sell Futures if a trader expects No Cut
• Since the decision exceeds expectations, S&P prices could go down sharply.
• With build-in leverage in futures contracts, a trader could realize enhanced profit.
Now, let’s explore how to structure trading strategies using S&P futures and options.
Hypothetical Fed Decision 1: Meet Expectations
Cutting rates is bullish for S&P as it will lower borrowing costs for component companies. However, since market already priced in a Fed cut, stock prices will not move a lot.
If a trader shares this view, he could explore selling Out-of-the-Money (OTM) Call Options on CME E-Mini S&P 500 futures (
ES).Each ES contract has a notional value of $50 x S&P 500 Index. On August 6th, the September ES contract (ESU5) is quoted at 6,341, making the notional value at $317,050.
• Call options at the 6500-strike are quoted at $42. By selling 1 call, options seller will receive $2,100 in upfront premium (= 42 x 50).
• Options expire on September 19th, two days after the FOMC. If ESU5 price does not exceed 6500, options seller will pocket the premium as profit.
• Warnings: selling options involves significant risks. Seller could lose more than the premium he collected. To cut losses, seller could buy back at the open market and exit the position. This will avoid losses to accumulate by expiration date.
Hypothetical Fed Decision 2: Exceed Expectations
Since rate cut is already priced in, an Unchanged decision will likely cause the S&P to fall sharply, as expected future borrowing costs will go up.
If a trader shares this view, he could explore selling CME Micro S&P 500 futures (MMES).
Each MES contract has a notional value of $5 x S&P 500 Index. On August 6th, the notional value of ESU5 is $31,705. Buying or selling 1 futures contract requires an upfront margin deposit of $2,135 at the time of this writing.
Micro S&P 500 futures are 1/10 in notional comparing to its E-Mini counterpart. With smaller size and lower margin requirement, the micro contracts are more approachable for non-professional traders. At the same time, they also enjoy the leverage built-in the futures contracts. Micro S&P contracts tap into the liquidity pool with the broad S&P contract suite.
Hypothetical Trade
• Short 1MESU5 at 6,341, and set a stop loss at 6450
• Trader pays $2,135 for initial margin
A “Meet” Scenario: S&P go up 1.5% to 6,436
• Short position loss: $475 (= (6436-6341) x 5)
• The maximum loss will be $545 if the S&P moves higher, due to the stop-loss feature
An “Exceed” Scenario: S&P falls 5% to 6,024
• Short position gain: $1,585 (= (6341-6024) x 5)
• The theoretical return is 74.2% (= 1585/2135), excluding transaction fees
Happy Trading.
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trading set-ups and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme/
Jim W. Huang, CFA
jimwenhuang@gmail.com
cmegroup.com/markets/microsuite.html
jimwenhuang@gmail.com
cmegroup.com/markets/microsuite.html
Related publications
Disclaimer
The information and publications are not meant to be, and do not constitute, financial, investment, trading, or other types of advice or recommendations supplied or endorsed by TradingView. Read more in the Terms of Use.
Jim W. Huang, CFA
jimwenhuang@gmail.com
cmegroup.com/markets/microsuite.html
jimwenhuang@gmail.com
cmegroup.com/markets/microsuite.html
Related publications
Disclaimer
The information and publications are not meant to be, and do not constitute, financial, investment, trading, or other types of advice or recommendations supplied or endorsed by TradingView. Read more in the Terms of Use.