How Do S&P 500 Futures Work?

S&P 500 futures are a type of derivative contract that provides buyers with an investment price based on the expectation of the S&P 500 Index’s future value. Investors and the financial media follow them closely because they act as an indicator of market movements. S&P 500 futures allow investors to hedge or speculate on the future value of the index by buying or selling futures contracts.

Investors can invest in these futures by buying and selling E-mini contracts through the Chicago Mercantile Exchange (CME) under the ticker symbol ES. In addition to E-mini contracts, micro E-mini S&P 500 contracts are also available for trade.

What Are Index Futures?

An index futures contract works just like a regular futures contract. It is a legally binding agreement between a buyer and a seller that allows traders to buy or sell a contract on a financial index and settle it at a future date. An index futures contract speculates on where prices move for indexes like the S&P 500.

Since futures contracts track the price of the underlying asset, index futures track the prices of stocks in the underlying index. For instance, Nasdaq and Dow index futures contracts track the prices of their respective stocks, and the S&P 500 Index tracks the stock prices of 500 of the largest U.S. companies. All of these index futures trade on exchanges.

The index futures contract mirrors the underlying cash index and acts as a precursor for price action on the stock exchange where the index is used. Index futures contracts trade continuously throughout the market week, except for a settlement period in the late afternoon U.S. Eastern/Central time, after stock markets close.

S&P 500 Futures

The CME introduced the first standard-sized S&P 500 futures contract in 1982. It was the base market contract for S&P 500 futures trading and was priced by multiplying the S&P 500’s value by $250. So if the S&P 500 was at a level of 2,500, then the market value of a futures contract was $625,000 or 2,500 x $250. The CME delisted standard S&P 500 futures and options at this price in Sept. 2021.

The S&P 500 E-mini Futures were launched in 1997, opening the market up for smaller investments by a wider range of investors. The "E" in E-mini stands for electronic, which means it's traded electronically. As such, it is a fairly efficient method of trading—much more efficient than the open outcry system was for traders when it was fully operational. Many traders opted for the E-mini ES over the SP contracts (when they were offered) because of their smaller investment size and their liquidity.

E-mini contracts are one-fifth of the value of the now-defunct big S&P futures contract. So if the S&P 500 hits 2,500, then the market value of an E-mini futures contract is $125,000 or 2,500 x $50. Just like all futures, investors are only required to front a fraction of the contract value to take a position. This represents the margin on the futures contract. These margins are not the same as margins for stock trading. Futures margins show "skin in the game" which must be offset or settled.

E-Mini vs. Big S&P Futures

Though the CME delisted the standard-sized contract for S&P 500 futures, it's still important to know how it differs from the E-mini.

First, there really is nothing a full-sized contract was able to do that an E-mini cannot. Investors and traders used both as tools for speculating and hedging. The only difference between the two was that the E-mini contract allows smaller players to participate with smaller commitments of money.

All futures strategies are possible with E-minis, including spread trading. And E-minis are now so popular that their trading volumes are significantly greater than the ones that were offered by standard futures contracts. E-mini volume is huge compared to the volume of the delisted regular contracts. This means that institutional investors generally use the E-mini because of its high liquidity and the ability to trade a substantial number of contracts.

Investors can also invest in micro E-mini contracts. Micro E-minis are valued at one-tenth of the E-mini. So if the value of the S&P 500 hits 2,500, the contract would be worth $12,500 or 2,500 x $5.

Cash Settlement of S&P 500 Futures

Industry experts created the cash settlement mechanism to resolve the massive logistical challenges presented by delivering the actual 500 stocks associated with an S&P 500 futures contract. The stocks would have to be negotiated and transferred between holders and would have to be properly weighted to match their representation in the index.

Instead, an investor picks a long or short position, which is then subject to a mark-to-market. The investor pays any losses or receives profits each day in cash. Eventually, the contract expires or is offset, and becomes cash-settled based on the spot value of the S&P 500 Index.

One of the often-proclaimed benefits of trading S&P 500 futures is each contract represents an immediate, indirect investment in the performance of the 500 stocks in the S&P 500 Index. Investors can take long or short positions depending on their expectations for future prices.

Large institutions may use S&P 500 futures to hedge positions in the index. With this approach, futures are often used to offset downside risks. Many investors use S&P 500 futures for speculation the same way they do with other types of futures contracts. An investor who takes a long position hedges their risk against losses if the index value rises (profiting when the price drops) while a short position does the same if the value decreases (gaining when the price rises).

S&P 500 Options

In addition to basic futures contracts, the CBOE also offers derivatives in the form of options contracts on the S&P 500. S&P 500 options have a full-value product and a mini. The full-value product has a ticker symbol of SPX with a multiplier of $100. The mini has a ticker symbol of XSP with a multiplier that is one-tenth the SPX. S&P 500 options contracts are also cash-settled.

The Bottom Line

S&P 500 futures, either E-mini or micro E-mini futures, allow investors to hedge or speculate on the future movement of the S&P 500 Index. These futures contracts allow for immediate investment in the S&P 500 index with the benefits of a regulated exchange and liquidity. Futures are a complex financial instrument and only experienced investors should utilize them for their investment strategies.