View

Futures vs. ETFs

December 5, 2005

 

The world of ETFs, or Exchange Traded Funds, has been exploding in recent years. At the end of 1993 there were globally three ETFs trading on two exchanges with $811 million in assets. But the ETFs in Morningstar's database now number more than 200, with ETFs now managing more than $260 billion, according to the trade association Investment Company Institute.

The main force that's driving this growth are ease of investment and lower costs. Because ETFs trade just like normal stocks, investors can easily see prices updated every tick and get into or out of the fund at any time of the day. And because they are passive investments that merely track the index, with no expensive active management, they are much cheaper than your run of the mill mutual fund, with annual expenses of 0.25% for the S&P 500 tracking SPDRs — cleverly referred to as Spiders.

But are ETFs truly the easiest and lowest cost method of exposure for stock indices. What about futures on stock indices – The S&P 500 futures, Russell 200 futures, and the electronically traded mini version of these contracts?

We're glad you asked – as it just so happens that stock index futures have the exact same traits as the ETFs in terms of ease of investment and low costs. But the stock index futures have many more advantages, starting with their more beneficial tax treatment in certain circumstances and their much smaller margin requirements.

A snapshot of the specifics of e-mini S&P 500 futures and SPDRs courtesy of the Chicago Mercantile Exchange is below:

A few things jump out on this page. One is the difference in transaction costs (or slippage, or execution costs). Another is the size of the two instruments. It takes 500 shares of the SPDRs to equal just one e-mini contract. Most active traders get some pretty deep discounts on share purchases, but it is still cheaper most of the time in terms of commissions to buy 1 emini rather than 500 shares. Finally - the good people who put together the SPDR and make sure it does indeed track the S&P 500 have to get paid, and that represents another extra cost the futures contract doesn't have.

The next interesting difference in the above table is the difference in required margin. For many traders, leveraging their money as much as possible allows them the most efficient use of capital possible - and in this department the futures trounce ETFs, with the margin for holding an emini futures contract only about 6% of the value. The current margin is only about $4,000 for holding a position overnight, versus a cash outlay of more than $30,000 for buying the 500 shares of SPDRs.

On top of that big difference, the margin requirement for merely day trading e-mini S&P futures (not holding the position overnight) can be as low as $1000 - or 1.5% of the contract value - which is clearly much less than the 50% margin deposit required to buy the SPDRs on margin. Another benefit of futures margining is that you won't pay interest on the margin posted for the e-mini futures position, and in fact may be able to earn interest on it by buying 30 to 180 day T-Bills in your futures account, which the exchanges allow to be posted for margin.

Despite the growing popularity of ETFs, futures simply dwarf the SPDRs in terms of average daily volume in dollar terms. With an average of around 830,000 e-mini S&P 500 contracts traded per day during 2005, and another 40,000 contracts or so traded in the full size S&P contract, there is roughly $65 Billion changing hands every day in the S&P futures at today's value of 1260. By contrast, about $6.4 Billion in SPDRs is traded each day; meaning the futures market is over 10 times larger.

Yet another major advantage of the futures is the ease with which a trader can sell the index short. By their very nature, in a futures trade one party must buy the contract and the other must sell it, so no special margining agreements are required, nor must the trader's brokerage firm come up with the shares for her to sell short. If the trader's account is at a small brokerage this can be an acute problem with the ETFs. Finally, futures are not subject to the "uptick" rule, whereby a stock can only be sold short on a tick up in price, a rule that is intended to prevent unscrupulous speculators from selling into a drop in price and artificially driving it even lower. In the futures, you can sell short anytime, anywhere.

The existence of options on the S&P futures is another advantage for the futures market. Although the options could be used in conjunction with positions in the ETFs, it makes little sense to do so given that each e-mini S&P 500 option is on one e-mini S&P 500 futures contract, and offsetting the futures and the ETF shares would incur significant extra commission costs.

If you are an active trader of ETFs, the tax advantages of futures will really be to your liking. Stock index futures are treated for tax purposes the exact same as commodity futures on actual commodities like wheat or crude oil This means they get special tax treatment - where all closed out profits and open trade profits as of the end of the year are taxed as if 60% were from long term capital gains and 40% were form short term capital gains (no matter how long you actually held your positions). If you're getting in and out of your ETFs a few times per year, would you rather pay 100% of the profits at the higher short term capital gains rate, or just 40% ? The answer is obvious.

Finally - the ability to cross margin futures positions with other positions and accounts makes futures the clear cut winner. For example, imagine an investor with $200,000 invested 50% in SPDRs and 50% in a futures account to trade several trading systems. Instead of having $100,000 actually invested in SPDRs shares and $100,000 sitting in a futures account, a sophisticated investor could simply have one futures account with $100,000. The account could hold the long ES position replicating the SPDRs holding, and use the rest of the margin to trade the trading systems. The other $100,000 that was tied up holding the SPDRs could be put in treasury bills, CDs, or some other type if investment.

In conclusion, it's no wonder the futures markets for S&Ps is over 10 times bigger than the SPDRs. They simply represent a more efficient instrument. If you are trading ETFs, maybe it's time you looked at the futures.

- Walter Gallwas

IMPORTANT RISK DISCLOSURE
Futures based investments are often complex and can carry the risk of substantial losses. They are intended for sophisticated investors and are not suitable for everyone. The ability to withstand losses and to adhere to a particular trading program in spite of trading losses are material points which can adversely affect investor returns.

Feature   |   Week In Review   |   Chart of the Week   |  

Chart of the Week : November Performance Summary

Feature   |   Week In Review   |   Chart of the Week   |  

The trends are back! November was the month trend followers have been waiting for as nearly every market trend in place in October extended right through November and into the early December, leading to big gains for trend followers.

The metals markets led the rally as products like High Grade Copper, Aluminum, and Platinum are seemingly in very high demand or very short supply. Last month alone NY High Grade Copper traded 10.03% higher, while its London counterpart was up 8.54%. There is also an interesting / nightmarish rumor coming out of London, as a rogue Chinese trader has disappeared after shorting millions of dollars worth of copper contracts. The precious metals Platinum and Palladium also traded higher with Platinum gaining +3.94%, and Palladium gaining an astounding +12.77% for the month.

Metals weren’t the only commodities rocking in November. Softs were also on a roll with Sugar futures gaining +9.71%, while Cotton dropped -5.05%. Meats traded higher as well with Lean Hogs gaining +3.06%, Feeder Cattle was up +2.66%, and Live Cattle traded 2.60% higher.

Energy prices surprisingly moved lower even though the temperatures around the US became much colder this past week. Unleaded Gas led the downward move as prices fell -9.11% in November. Crude Oil was right behind unleaded falling -5.69%, and heating oil prices dropped -10.03%. The one market that did not fall drastically was Natural Gas leading many to speculate that the price of Gas will continue to rise drastically as temperatures get colder and supplies dwindle.

Even though commodity traders had a big month stock traders were not left too far behind — as stock indices rallied worldwide. In the US, the benchmark SP 500 futures contract gained 3.41% and it had the WORST month out of all of the US stock indices. NASDAQ futures led the way gaining +5.58%, while Small Caps continued their 2005 rally with Russell 2000 futures gaining +4.45% and Midcap 400 futures gaining +4.50%.

Foreign Stocks were even hotter than US stocks, especially in Asia, which saw Nikkei 225 futures gaining +8.55% and Hang Seng futures gain +9.90%. European stocks also had a great month with German DAX futures gaining +5.67%, Eurostoxx 50 futures were up +4.25%, and FTSE 100 futures rallied +2.18% higher.

In contrast Bonds of both the US and European variety ended the month virtually unchanged as an early month sell off was offset by a late month rally. Foreign currencies did pick up some of the slack however with Eurocurrency (-1.82%), the Swiss France (-2.26%), and Japanese Yen (-3.21%) all moving lower against the US Dollar. The US Dollar Index finished the month +1.76% higher.

*Day Trading**

Day trading systems were overshadowed by some good performance from their swing and long term counterparts in the month of November. This further confirms the power of diversification across time frames - as those investors involved in all three types of trading systems most likely came out on top for the month even if the day trading portion of their portfolio finished in the red.

Of the short-term systems, an elite group of systems finished the month with positive returns. Compass SP took the top spot with profits of +$1358.17 for the month. Helix ES was less active than usual but made an impressive +$567.50, while, Electric Daybreaker II NQ was the only “charged” market of the family with gains of +$145 per contract. Finally, Impetus eRL and R-Mesa eRL had nearly identical results with gains of +$56 and +$55 per contract.

The next group of systems merely treaded water for the month. RC Success ES lost -$50 on ten trades for the month. Electric Daybreaker eRL and ES lost -$85 and -$105 a piece. Nautilus ES traded just one time in November for a loss of -$230. The system requires volatility that was not present for the majority of the month which kept it on the sidelines. Lastly, Clipper eRL lost -$695 on 14 trades.

Elsewhere, the rarely active Spectrum eRL and Spectrum SP both traded twice in the second week of November, but unfortunately saw losses of -$1,048 and -$4,125 respectively. RC Miracles ES underperformed for the month dropping a somewhat large -$2,017.50 for an emini system, while Daybreaker SP had several whipsaw trades adding up to losses of -$2,878.53. Finally, R-Mesa SP struggled to get on the right side of the market and lost -$4,753.13.

**Swing Trading**

Swing trading systems proved they are force to reckoned with in November (for the most part). With a slow and steady upward trend in the stock market from the October lows serving as the catalyst, swing trading systems have slowly added profits and now make up 4 of the top 5 systems traded at Attain for the year.

At the top of the YTD list and once again at the top of the monthly performance list is Axiom eMD. The system has simply been on fire since its release in mid 2004 and is currently earning 56.35% YTD (based on a 15k account after all commissions and lease fees) and earned +3,604.50 in open and closed trade equity in November. Not far behind Axiom in the annual ranking is its sister system Delphi, which was just released in September. Talk about good timing, Delphi eMD is currently earning +33.3% and Delphi eRL is earning +25.7% YTD (based on a 15k account after all commissions and lease fees). In November each system added to the bottom line by earning +$2,180 and + $1,590 in open and closed trade equity.

In addition to the above highlights, Eclipse traders were excited to see the system post its largest single month gain of the year, with +$4,086.70 in open and closed trade profits in November. Eclipse had a very difficult stretch in August as it hit new maximum real-time drawdowns; but as we see time and again with systems as they cycle in and out of their profitable cycles, the system has been able to come back and is now just $3,900 away from a new equity high.

Other positive index trading included the following: Axiom ES +2,712.50, Axiom eRL +1,738.70, Tzar eRL $1,960, Tzar ES +$1,757.50, Athena eRL +$770, and Seasonal ST +$942.50 on 4 well timed trades. Tzar NQ and eMD were the only index programs with losses on the month as they ended down -$340 and -$1,855 respectively. It is noteworthy that both are now correctly holding long with nice open trade gains.

Not to be out done by its index counterparts, Axiom Crude 90 recorded open and closed trade gains of +$3,510 in November. Other investors trading Axiom Crude 135 also had small gains of +$250. Because the CL 90 uses a much shorter time frame it has a tendency to enter into trades ahead of the 135.

In bond trading the results were mixed as investors jockeyed back and forth while guessing whether the US Fed plans to continue raising interest rates. The other question, which has since been answered now in December, was whether the European Union was going to begin their anti-inflationary efforts…the answer was apparently yes, as the EU raised their short term interest rate by .25 late last week. In November both Mesa Bonds and Notes added to their open trade equity. Respectively they gained +309.375 and +418.75. Unfortunately Jaws Narrowneck was not as fortunate, as it lost $5,400 on the month.

**Long Term**

As we alluded to in the intro — Trend Following systems had their best month to date in 2005. It isn’t hard to see which markets provided the most success for long term traders as big trends in Metals and Softs were supported by smaller trends in the grains, stock indices, and foreign currencies. Looking ahead to December and the end of the year it is going to take another huge effort in December for most trend followers to post numbers in the black in 2005. However, one has to think, that given success most trend followers have found in the October and November, trend following has regained the respect and confidence of investors worldwide.

A glimpse at the current open positions held by most long term systems will tell us where the markets need to go in order for December to be just as successful as November. The same trends which have worked in October and November need to continue — as most systems are holding long metal, long sugar, short foreign currency, short grain, and short bond positions. The one group of markets that is noticeably absent is the energies, and perhaps new long or short positions could sway the tide in December and early 2006 for trend following systems.

Current open closed out system trades for November include:

Aberration Plus holding long in LME Aluminum for profits of +$3469.60 per contract, in Sugar for gains of +$2234.80 per contract, and in the Mexican Peso for gains of +$1075.00 per contract. One trade that has not panned out thus far is a short position in the Euro Bund which is losing -$1010.00 per contract.

Andromeda had a good month as well with open positions including a long position in Platinum for gains of +$3865.00 per contract, a long Dollar Index position for gains of +$1990, and a short Soybean trade for gains of +$1737.50 per contract. Andromeda was stopped out of a couple trades in November notably in the KC Wheat for a loss of -$925.00 per contract.

Axiom LT made its mark in the Dollar Index for profits of +$1585.00 per contract and in the London Sugar for profits of +$1535.00 per contract. Axiom LT has also been the only system to venture into the energy arena with a short crude oil trade that is losing -$430.00 per contract.

Brix had a successful month headlined by a short Eurocurrency trade with open trade profits of +5800.00 per contract and a short Swiss Franc trade with open trade profits of +$4150.00 per contract. This system also has profitable open positions in Soybeans for gains of +$1625.00 per contract, in wheat for profits of +$275.00 per contract, and in Cotton for profits of +$715.00 per contract.

Finally, SEMA4 Symmetry rebounded with nice open trades in Sugar for profits of +$2514.80 per contract, in the Dollar Index for profits of +$4650.00 per contract, and in the Canadian Dollar for profits of +$920.00 per contract. All of these profits helped the system overcome a long crude oil position that lost -$10,880.00 per contract, and post profits for the month.

Please Login to: http://www.attainaccess.com for the latest updated statistics.

IMPORTANT RISK DISCLOSURE
Futures based investments are often complex and can carry the risk of substantial losses. They are intended for sophisticated investors and are not suitable for everyone. The ability to withstand losses and to adhere to a particular trading program in spite of trading losses are material points which can adversely affect investor returns.

Feature   |   Week In Review   |   Chart of the Week   |