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Tearing apart the e-mini Myth - Is there really better execution and liquidity?

March 6, 2006

The conventional wisdom around many futures brokerages these days holds that the e-mini contracts have such a superior edge in liquidity that it is better to trade 5 e-minis instead of 1 full size contract. The logic most brokers use says the better liquidity means less slippage, and therefore better performance because the reduction in slippage will more than offset the extra commission costs associated with FIVE round turns versus ONE.

Attain Capital has never been one to believe in the conventional wisdom, however, and we continuously monitor whether it is in fact advantageous to execute 5 e-minis. The claims of "better liquidity" in the eminis are curiously never tested by brokers espousing 5 minis vs 1 full size S&P - and without such statistics to actually show there is better performance, it seems many brokers are simply after 5 times the commission, not better performance for your account.

In the study below, we looked at the execution difference between the full size S&P and emini S&P on nearly 400 actual trades in client accounts using the Compass system from Apr 16, 2003 through the end of February. We found once again that the costs of trading 5 e-minis far outweigh the execution benefits - to the tune of just over $15,000 if paying commissions of $40 per full size S&P and $20 per e-mini S&P.

This table is for comparison purposes only. Past performance is not necessarily indicative of future results. Please see important risk disclaimer below.

As you can see in the table above, the performance of the Compass system using e-mini execution was better by $17 per trade, or a little less than 1 tick in the S&P futures (1 tick = $25 and there are 10 ticks per point). While at first glance this appears to favor the 5 e-mini argument, execution is not done in a vacuum, and the extra cost of doing 5 times the number of contracts on each trade must be factored in. After factoring in a full size contract commission charge of $40 and an e-mini commission charge of 1/2 that, or $20, we found that the costs overcame the execution savings and made trading 5 e-minis a losing proposition. Rates do vary, however, so we came up with the following formula to calculate the e-mini rate needed for the 5 e-mini instead of a full size contract plan to be valid.

R/T E-Mini Rate < (R/T Full Size Rate + Execution Benefit) / 5

The formula is simply adding whatever execution benefit exists with the e-minis as a "penalty" to the full size rate, as that equals the per trade benefit of doing 5 e-minis. Thus, in order for the e-mini execution to be beneficial for an investor, an investor's round turn e-mini rate must be less than the investor's full size Round turn rate plus the execution benefit ($17 in this case), divided by $5. For example, with a $35 full size contract rate, an investor's e-mini rate must be $10.40 per round turn or less.[(35+17)/5 = 10.40)].

Now, e-mini commissions are regularly less than full size commissions. But how much less is the key question in this debate, and one often overlooked. If it were a perfect world and the cost of trading one e-mini was 5 times less than the cost of trading a full size S&P, Attain Capital would join the 5 minis camp - but that is not reality, especially for investors having trading systems executed for their accounts.

The reality for investors having a trading system executed for their account with e-mini contracts is a round turn commission rate between $15 and $30. An investor comparing e-mini execution at a $15 rate versus full size execution at a $40 rate would need to see at least $50 savings per trade - or 2 ticks on the full size S&P. Those savings just haven't been seen.

The numbers show once again that better cost adjusted performance is available trading 1 full size S&P instead of 5 minis. If your broker is telling you to trade 5 e-minis instead of a full size contract, he may as well be telling you he would like to see you have worse performance per year. The choice is yours, choose wisely.

Why is the slippage savings so much less than anticipated? One reason is that trading system's are designed by many developers to incur as little slippage as possible. How do they accomplish this? - with limit entry orders, exits 5 minutes before the close of the day, no trading on Fed days, and other tricks of the trade. The result is a minority of trades receiving no slippage at all.

Another interesting factor to note is the decreasing spread in the full size S&P. Slippage is a function of the spread between the bid and ask price in any market, and the average spread of the bid/ask in the S&P has fallen in recent years in response to the dramatic increase in electronic volume. With e-mini spreads typically 1/4 a full point and full size spreads closer to 1/2 a point in the past, it's easy to see how a case can be made for the minis. But the brokers in the S&P pit have had to try and get their spreads as close to that as possible so as not to lose all their business to the electronic minis, and the fill data has shown it is coming down.

There is also the professional execution to consider. Attain Capital employs filling brokers at the Chicago Mercantile Exchange trained in executing trading system orders. This service costs clients an extra $2 per trade, but it is worth every penny if it can save a few ticks per trade in slippage - or even cause that rarest of events - positive slippage. Professional execution could be the biggest factor in the divergence of the expected savings and real-time savings, as the majority of system execution firms use their respective clearing firms' "Fill 'em and Bill em" brokers, which is akin to paying retail price versus wholesale.

So that broker trying to convince you to trade 5 e-minis instead of the full size contract may not be lying to you - he may simply be leaving out some facts. His S&P fills may be so bad that paying 5 times more in commission makes sense, but he isn't telling you better S&P execution is possible. He probably doesn't want you to transfer your account to Attain.

I would be happy to report that trading 5 e-minis would be more beneficial for all investors out there, as Attain Capital's revenues would suddenly increase 5 fold, but I can not support that which I do not believe. The debate will rage on, but Attain Capital will weigh in on the side of full size contracts, given you have your own S&P filling brokers as we do.

- 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.

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Chart of the Week : Ping Systems Performance Summary

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The Week in Review: Systems struggle as US Equities remain stagnant.

***Overview***

February was a tough month to be a short term equity trader due to gridlock in the markets. SP 500 futures traded in a 43.60 point range for then entire month as traders refused to establish themselves in one direction or the other.

News stories making headlines last month included another Fed interest rate hike, rising tensions in Iran, along with downgrades of several tech heavyweights including the Google, which by itself now accounts for just over 2% of the market cap in the NASDAQ. Despite all this the futures markets were not hit very hard with SP futures falling only -1.20 points for the entire month. NASDAQ futures fell -2.62% but this was mainly due to the GOOG downgrade. Smallcaps also traded lower with Russell 2000 futures falling -0.64% and SP Midcap 400 futures fell -1.19%.

Elsewhere, consumers finally got a small reprieve from escalating energy prices as warmer temperatures and promises of continued full capacity output by OPEC kept a lid on these volatile markets. Leading the way to the downside was Natural Gas which fell an unbelievable -29.32%. With winter drawing to a close it appears that all the doomsday predictions of Natural Gas shortages will be unfulfilled. Unleaded Gas futures also were hit hard falling -18.71%, Crude Oil futures fell -10.86%, and Heating Oil futures fell -8.78%.

The Metals markets also cooled off a bit with Platinum futures falling -2.82%, Palladium futures dropped -2.63%, Gold was down -2.02%, and Copper fell -1.22%.

US Bond futures and foreign currency futures had a slow month but it appears that both sectors are opening up a bit so far in March. In February US Bond futures fell -0.22%. 10 year note futures fell -0.35%, Eurocurrency futures dropped -2.04%, Swiss Franc futures fell -2.83%, Japanese Yen futures rose +1.07%, while US Dollar Index futures rose +1.43%.

Ironically, trading was brisk in the Grain and Meat markets which are typically much slower the bonds and currencies. Grains rallied higher due to their potential use in Ethanol production and a drought in Europe. Wheat futures led the way to the upside with Kansas City Wheat gaining +12.60%, Minneapolis Wheat was up +6.27%, and CBOT Wheat was up +7.40%. Elsewhere in the grains Corn rallied +4.03% higher while Soybeans fell -2.30%.

Finally, in the tropical markets Sugar futures pulled off their record setting pace dropping -4.99%, while Cotton fell -3.18%, and Coffee dropped -6.19% for the month.

***Day Trading***

Choppy conditions in equities for the majority of the month sent several day trading systems for a loop in February. Systems that did perform well for the month generally jumped into trades ahead of the pack - often entering before a major daily trend had even begun to develop.

Mastering this technique, RC Success eRL took top honors for the month with profits of +$1,539.70. RC Success eMD was no match for the eRL but still managed to tack on +$353.50 in profits. Bounce eRL had just one trade that made +$240-often in month like this less is more when it comes to number of trades. Switching gears, Tanker CL was able to profit +$200 in the Crude Oil market but was rather quiet with just 4 trades for the month.

Those that didnâ€™t perform as well got caught up in momentum trades-buying the daily highs and selling the lows in hopes of breakout moves - but the buys and sells were often around key psychological trading levels that provided support and resistance.

Impetus eRL had a slow month with just three trades for a loss of -$446.70 per contract. RC Miracles eMD and eRL were not as successful as the other RC programs, down -$450 and -$480 respectively for the month. Bounce eMD didnâ€™t follow the path of Bounce eRL, losing -$530 on a single trade, while. RC Success ES lost -$1,400 trading roughly 4 times per week for the month.

Elsewhere, R-Mesa 5 had another tough month losing -$2,044.12 but had a b second half of the month to trim the losses from the first week. Compass had similar struggles and lost -$3,291.60 in February.

***Swing Trading***

Stocks may have closed the month right where they started, but there was plenty of action for swing trading systems in between.

The best swing system in February was the Tzar system - which ended the month profitable in all 6 of the markets it trades for a grand total of +$12,345.94 in open and closed trade gains in February! What are the 6 markets â€“ Tzar was originally designed to operate well on any market, but was initially applied to the more volatile US stock indices (SP, ND, RL, and MD) where results were most favorable. Since inception of the program approx. 3 years ago we have also applied trading of the system to several foreign markets which has turned out to be a fantastic addition to several investors portfolios. In February Tzar Dax added +3,212.50 Euros and Tzar Hang Seng added +19,600 Hong Kong Dollars = approx. 2,426.44 US Dollars. Currently Tzar is short all US markets while holding long the 2 foreign.

In other trading - the results were mostly unfavorable. Here were the index results for February in descending order: Axiom ES +$110, Bounce eRL +$70, Axiom NQ -$333.74, Bounce eMD -$550, Delphi eRL -$661.10, Eclipse eRL -$800, Delphi eMD -$972.60, Axiom eMD -$981.60, Athena eRL -$1,030, Axiom eRL -$1,416.90, SeasonalST ES -$1,690, and SeasonalST eRL -$2,970.

Bond trading was also mixed as investors jockeyed to comprehend the long term effects of yet another rise in interest rates and a new Federal Reserve Chairman. Mesa Notes added +$103.125, Mesa Bonds gave back -$229.6875, and Jaws Narrowneck lost -$1,096.875 but was able to lock in approximately $1,087.5 last Friday.

***Long Term***

Long term trend following system performance was mixed in February with SEMA4 Symmetry and Brix pushing higher while Aberration, Andromeda, Axiom LT, and Trend Simplicity all moved slightly lower.

Trend followers had the most success in the grain and meat markets as both sectors trended fairly well in February. Grains traded higher due their potential use in Ethanol production and less than ideal trading conditions in Europe.

Systems taking advantage with long positions in the Grain markets include SEMA4 Symmetry which is long in KC Wheat for open trade profits of +$4187.50 per contract and long in Minneapolis Wheat for open trade profits of +$1412.50 per contract. Brix is making +$2362.50 per contract (open trade) in CBOT Wheat and is also shot in Soybeans for open trade losses of -$1075.00 per contract. Other long grain positions include Aberration holding long in soybean oil for open trade profits of +$28.00 per contract, Andromeda holding long in corn for open profits of +$625.00 per contract, while also holding long in KC Wheat for open trade profits of +$2675.00 per contract. Finally, Axiom LT is making +$2025 per contract (open trade) in Minneapolis Wheat.

Trend followers also had success in the meats which traded lower throughout February allowing systems to establish short positions. A quick recap of systems with short positions includes Axiom LT which is short in Live Cattle for open trade profits of +$2170.00 per contract and Aberration is short in live cattle for profits of +$1360.00 per contract.

One trade that did not work for many systems in February was going short in Eurocurrency. EC trended lower for most of the month but a quick pop upwards at the end of February stopped out most systems with short positions. Systems that exited include Andromeda for a loss of -$-1787.50 per contract and Trend Simplicity for a loss of -$1350.00 per contract. Other notable losing trades include Brix losing -$2400.00 per contract in Soybeans and Axiom LT lost -$1350 per contract in London Gas Oil.

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