The Equity Index Dividend futures complex provides investors with efficient tools to hedge or express their views on the U.S. dividend market. They provide a transparent view on future implied dividend distributions along the curve with maturities going out 10 years. Using Dividend futures, investors can seek dividend-based opportunities around the following:

1. Directional views on dividends which are deemed over valued (sell) or under valued (buy).
2. Calendar spreads: Investors can combine the buying and selling of Dividend contracts in different maturities and can also express views on future dividend spreads between different years. 
3. Relative value trading across indices: For example, if investors believe that there could be further upside in the technology sector dividends compared to other sectors, they could trade futures on the Nasdaq-100 Annual Dividend Index (going long) against S&P 500 Annual Dividend Index futures (going short). 
4. Access dividend exposure efficiently irrespective of the price movement of the underlying benchmark index.

Equity Index Dividend futures are cash-settled derivative contracts whose underlying is “index dividend points” which measures the gross dividends declared and paid by the constituents of an equity index during a predetermined period.

Quarterly and annual futures contracts are available on the S&P 500 Index, allowing greater flexibility and fine-tuned dividend exposure. Annual contracts are also available on the Nasdaq-100 and Russell 2000 indices as summarized in Exhibit 1. Recently, options on S&P 500 Annual Dividend futures have been introduced allowing market participants access to a product for trading dividend index volatility through option strategies.

Source: CME Group

The S&P Global Market Intelligence Dividend Forecasting unit projects the 2024 global aggregate dividend to stay largely flat at $2.2 trillion, up only 0.7% year over year. Regular dividends are expected to see 4% growth. The optimism in the world’s largest dividend-paying equities market stands out, widening the gap with the rest. The growth is driven, in part, by the companies that reinstated dividends in 2023 after the pandemic-induced cuts, with a few more expected to do so in 2024. Banks and energy sectors are expected to dominate the dividend scene, according to S&P Global Market Intelligence ^[1].

Implied dividends can trade differently depending on their maturity. While bottom-up forecasts are a key driver of value for near-term implied dividends up to 10-year maturities, the longer-dated implied dividends often trade more as a yield. As such, the longer-dated implied dividends tend to be highly correlated with spot to maintain a relatively stable dividend yield. Issuance in the form of structured products is also typically reflected in the valuations for longer-dated maturities. 

Interestingly, S&P 500 Dividend futures are expecting the growth in dividend payouts over the next decade to be lackluster. What they imply about the equities market being overvalued tends to reinforce concerns of the potential for exceptional market volatility ahead. Some of the gloomy outlook could be due to corporate earnings being near record highs as a percentage of the economy, making it challenging for further significant gains. 

Summarizing the longer-term trends for dividends in broad terms: 

• The equity payout story is structural and can pivot on corporate earnings. 
• Driven by tax policies.
• Incentives for companies have been to buy back stock rather than return capital to shareholders.

Managing dividend risk exposures across U.S. indices is expected to be active. Indeed, investor demand has grown across all four Equity Index Dividend futures. Averaging around 4,600 contracts of daily volume that is equivalent to an average notional value of $17 million and average open interest notional value of $4.6 billion in 2023. Equity Index Dividend futures provide a rich assortment of varied earnings streams to help investors manage risk. The growth in these futures has been driven by the need to manage dynamic dividend risk within these indices.

Summarized below are some of the use cases of Dividend futures.

• Hedging: Dividend futures can be used as the underlying basis to hedge dividend risk embedded in index derivatives. Market participants such as option traders and issuers of total return based structured products constantly need to manage their dividend risk proactively. Even equity portfolio managers, especially equity income fund managers, have meaningful exposures to dividend risks. Given the changing dividend environments, market participants exposed to dividend risks may wish to hedge their exposure.

• Arbitrage: Implied dividend points deviate and may often underestimate realized dividends. In such cases, this may provide an opportunity to execute index-linked dividend arbitrage strategies.

• Calendar spreads: Implied dividends are generally driven by dividend growth expectations and perceptions of risk to dividends. As such, the implied levels incorporate a “dividend risk premium” which is compounded with increasing maturity. This provides opportunities to execute calendar spreads between longer-dated and shorter-dated dividends. Investors can combine the buying and selling of dividend contracts in different maturities and can also take views on future dividend spreads between different years.

Index dividend trading opportunities appeal to different investor types, including:

• Hedge funds and proprietary trading desks: Hedge funds and proprietary trading desks have historically dominated the client base for dividend trading, isolating dividends for dividend risk management and risk transfer along the curve.
• Equity investors: As implied dividends appear cheap compared with analyst estimates, an investor can replace an equity position with a dividend position. Pension funds, endowments and insurance portfolios may need to hedge their dividend income risk. Asset owners may also be willing to buy dividend futures to hedge out dividend fluctuation risk in order to better match their liability streams.
• Relative value investors: Trading the implied dividend yield in the equity derivative market.
• Macro investors: Macro views can be implemented using dividends for different markets – either naked long or long-short. Investors can also trade an anticipated turn in the economic cycle. This may be initiated by going short near-dated dividends and long far-dated dividends to benefit from the low implied dividend growth rate.
• Interest rate investors: Trading the correlation between dividends and interest rates. Empirically, there is a high correlation between dividends and spot across the entire implied dividend curve. An investor who would normally invest in the rates market could consider investing in dividend yield instead and benefit from the cheapness in the implied dividend market.
• Inflation desks: Investors can look at YoY growth of dividends and the forward-looking dividend curve as a hedge to inflation.

Equity Index futures and options are important tools portfolio managers use to maximize capital efficiencies, minimize portfolio risks, execute both long and short positions and generate portable alpha. Key benefits of futures include, but are not limited to:

Liquid granular execution strategies

• Liquidity: The S&P 500 Annual Dividend futures had in 2023 average notional daily liquidity of $61 million and open interest notional of $3.6 billion.
• Transparently manage positions: Flexible execution, including block trades and liquid screen trading capabilities offer multiple ways to manage liquidity risk.
• Taking a short position: For futures, entering a short position is operationally equivalent to entering a long position.

Trading with expiries along the curve

• Range of futures expiries which allow investors to fine tune their exposure:    
  • S&P 500 Quarterly Dividend Index futures: first five months in March quarterly cycle.
  • S&P 500 Annual Dividend Index futures: Nearest 11 December annual contracts.
  • Nasdaq-100 Annual Dividend Index futures: December annual contracts listed for six consecutive years.
  • Russell 2000 Annual Dividend Index futures: December annual contracts listed for six consecutive years.

Capital efficiencies and margin offsets

• Optimize capital deployment: S&P 500 Annual Dividend futures margins are currently 2-3% and subject to change.
• Margin offsets: Traders may qualify for margin offsets with other CME Group contracts, including offsets specific to the underlying Equity Index futures.

Key features:

• Equity Index Dividend futures and options are important tools portfolio managers use to maximize capital efficiencies, minimize portfolio risks, execute both long and short positions.
  
• Equity Index Dividend futures can help investors who seek dividend trading opportunities and express their views either as directional, or calendar spreads or as a relative value strategy or even isolating dividend exposure.
• Dividend futures allow for trading, transfer and hedging of dividend risk exposure that is standardized, exchange listed and offers a transparent listed block and screen alternative to the OTC market.

S&P 500 Annual Dividend futures contracts are based on the underlying S&P 500® Dividend Points Index (Annual) index. The focus will be on this dividend index as an example. Russell 2000 Dividend Index and Nasdaq-100 Dividend Index follow similar approaches in their respective methodologies, detailed in the appendix.

S&P 500® Dividend Points Index definition

The S&P 500® Annual Dividend Index is designed to track the running total accumulation of dividends paid by S&P 500 index constituents during the respective Index reference period.¹ The reference period for the Index is one year, spanning from the day following the third Friday of the preceding December to the third Friday of the current December. The Index resets to zero at the beginning of each reference period. Index providers calculate dividends paid and report them in index points and the amounts grow over the period. At expiration, the accumulated dividends revert to zero. This cycle is charted in Exhibit 3 that shows a typical sawtooth seasonal aspect of dividends of the S&P 500® Dividend Points Index (Annual)^[2]. For the S&P 500® Dividend Points Index (Quarterly), a similar pattern exists.

Dividends are added on the ex-date.

On each business day within a given Index reference period, the dividends of all S&P 500 index portfolio stocks “going ex-“ that day are summed up and the total is divided by S&P 500 index’s prevailing index divisor, which converts the index in USD amount into index points. Except for the reset day where applicable, these index points are added to the cumulative total for the respective period to derive the value of the Index for that day.

On any given day within a given Index reference period, SPDJI calculates the Index using the formula:

Index(t) = ∑_r=0…t ID_(r)

Where:

ID (r) = the index dividend of the underlying index on day r.

r is the running variable that marks passage of time, by business day, within the current Index reference period.

r takes values between 0 and T, such that r = 0 at close of business on the third Friday of the first calendar month in the Index reference period (December) and r = T at close of business on the third Friday of the last calendar month in the Index reference period, the following December for the Index.

The index dividend (ID) of the underlying index is calculated on any given day as the total dividend value for all constituents of the index divided by the index divisor. The total dividend value is calculated as the sum of dividends per share multiplied by index shares outstanding for all constituents of the index which have a dividend going ex on the date in question. In the definitional equation above, ID(r) is the S&P 500 index dividend on day r:

ID(r) = [ ∑k=1…K Dividend(k) * Shares(k) ] / Divisor(r)

k indexes S&P 500 index constituents (1, 2, … , K) for which dividends go ex on day r.
Dividend(k) is the dividend per share that goes ex on day r for S&P 500 constituent k.
Shares(k) is the number of shares outstanding on day r for S&P 500 constituent k.
Divisor(r) is the S&P 500 index divisor value for day r.

All dividend futures reference a dividend points index to determine their final cash settlement value. In particular, the S&P 500® Dividend Points Index (Annual) tracks the cumulative amount of S&P 500 dividends paid during the year. For example, on 30 January 2023, an investor took a long position in the S&P 500 December 2023 dividend futures traded at $67.55. As of 15 December 2023, the settlement date, received the value of the actual S&P 500 Dividend Points Index (Annual), $70.24 the settlement value of the December 2023 contract.

For dividend futures investments, the up-front payment an investor must commit is the margin required by the exchange (typically, 3%-5% of the contract’s notional value). For example, if the notional price of the dividend futures contract was $67.55, the margin requirement would be around $3, which serves as collateral at the time of purchase to cover potential losses. That is how dividend futures provide leverage. The dividend futures position can also be taken without employing any leverage. An investor can pledge the collateral amount equivalent to the notional amount, $67.55, of the dividend futures contract, which would be full collateralization.

Historical dividend points

Exhibit 4, below details the S&P 500® Dividend Index (Annual), Russell 2000 Annual Dividend Index and Nasdaq-100 Annual Dividend Index historical dividend points at the end of each annual reference period. For the annual dividends, this is the third Friday of the last calendar month in the Index reference period, i.e. the December month.

Over the 8 year period between 2016 to 2023, it is noted that:

1. The S&P 500 had the highest dividend yield averaging at 1.75% of the three indices followed by the Russell 2000 at 1.31% and then Nasdaq-100 at 0.92%.
2. Index dividend points delivered each year have been generally increasing year-on-year bar pandemic impacts.
3. As the index dividend points have increased, given the rapid price increases in the indices, the dividend yield has generally declined in the S&P 500 and Nasdaq 100.

Source: Bloomberg, SPICE , FTSE Russell, Nasdaq, Index level the third Friday of the last December month in the Index reference period.
S&P 500^® DIVIDEND INDEX (ANNUAL), Russell 2000 Annual Dividend Index and Nasdaq-100 Annual Dividend Index.

1. The following paragraphs on index methodology are adapted from S&P U.S. Indices Methodology, S&P Dow Jones Indices, December 2023 at: https://www.spglobal.com/spdji/en/documents/methodologies/methodology-sp-us-indices.pdf.
2. S&P Dow Jones Indices, S&P 500 Dividend Points Index (Annual)
   

Each index provider calculates a dividend yield based on their valuation of dividends and the specific indexes divisor at that time. Timing in dividend payments is important and the methodologies as calculated for the Nasdaq-100 Dividend Point Index and the Russell 2000 Dividend Index are provided below.

Nasdaq-100 dividend point methodology

The Nasdaq-100 Dividend Point Index (NDXDIV) is calculated as the running total of ordinary dividends paid by the constituents of the Nasdaq-100 Index (NDX), expressed in index points. The Index is reset to zero once a year in connection with the derivatives expiration on the third Friday of December.³ Which can be expressed as follows:

Exhibit 5: Nasdaq-100 dividend point formula

I_t = Index level at time (t)

q_i,t = Number of shares of company (i) applied in the NDX Index at time (t)

d_i,t = Ordinary dividend per share for company (i) with Ex-date at time (t)

Index Divisor = The divisor for NDX Index at time (t)

Source: Nasdaq

Russell 2000 Dividend Index methodology

The index will represent the cumulative value of ordinary cash dividends announced and paid by the individual constituents of the underlying Russell 2000 Index, calculated in terms of index points. FTSE Russell will rebase the index to 0 at the start of the first trading day following the third Friday in December each year. The ex-dividend adjustment represents the value of dividends declared by constituent companies on the ex-dividend date expressed in index points. The ex-dividend adjustment year to date is the calculation on a cumulative basis for the period between and including the first trading day following the third Friday in December to mid-day on the third Friday in December of the following year. ex-dividend adjustments are based on declared dividends is calculated as follows:⁴

I_t = Market Value of Dividends / Latest Index Divisor

I_t = Index level at time (t), Source: FTSE Russell

3. NASDAQ-100 DIVIDEND POINT INDEX Methodology
4. Russell 2000 Dividend Index Ground Rules

[1] Dividend growth across all sectors,
https://cdn.ihsmarkit.com/www/pdf/0124/Seven-key-dividend-forecasts-for-2024_.pdf?utm_source=linkedin&utm_medium=social

Gormsen, N., R. Koijen, and I. Martin (2021). The Pricing and Risk of Dividends by Maturity: Theory and Evidence from the COVID-19 Pandemic. American Economic Association Papers and Proceedings forthcoming.

Gormsen, N. and R. Koijen (2020). Coronavirus: Impact on Stock Prices and Growth Expectations. Review of Asset Pricing Studies 10(4), 574–

Implied Dividend Volatility and Expected Growth, By Niels J. Gormsen, Ralph S.J. Koijen, and Ian W.R. Martin,   https://personal.lse.ac.uk/martiniw/GormsenKoijenMartin20210107.pdf