Case Study: Finding an Efficient Hedge for Equity Sector Exposure

Over 15 years ago, CME Group introduced the first of many Equity Index Sector futures products. Today, nearly 20 products fall within the CME Group Equity Sector product suite. Recently, six new sector products were added, expanding access to Semiconductor, Biotechnology, and U.S. Regional Banks indices.

Sector futures products not only come with broad applications, they also can offer multiple capital efficiencies to a range of clients.

Compared to ETFs and swaps, CME Group Sector futures offer notable capital savings for clients looking to trade a portfolio. The following example shows the substantial difference in capital efficiency potential between the three ways to trade sector exposure. Learn more about the capital efficiencies found in Equity Index derivatives here.

Assume a trader is looking to trade a $300M portfolio across various sectors, using the most capital-efficient method. To determine which financial instrument to use, the trader completes a quick, high-level analysis of the capital required to purchase the same notional exposure across CME Group Sector futures, ETF equivalents, and a swap equivalent.

Table 1 shows the desired sector distribution for the portfolio in question, and the amount of margin or capital required to execute the trades using the three different types of trading instruments.

*Futures margin as of February 2023. Source: CME Group

Using ETF and futures prices as of February 15, 2023, Table 2 shows the number of contracts and capital required to trade the $300M portfolio.

The number of ETF and swap units was calculated by dividing the capital required for each sector by the respective ETF and sector index prices on Feb. 15. Similarly, using the notional value per futures contract, we determined the number of contracts required for each sector in the portfolio and the associated margin.

Source: CME Group

Explicit trading commissions, bid-ask spread, liquidity, counterparty risk and capital efficiency all factor into the decision of which instrument may be optimal to use. Capital efficiency has become increasingly important as the phasing in of regulations, such as Uncleared Margin Rules (UMR), has impacted the OTC space and a rising rate environment, which in turn impacts the decision whether to gain access via fully funded products such as ETFs.

As can be clearly identified from table 2, there is a notable difference between the capital required for fully funded ETFs and Sector futures. In this $300M portfolio example, a capital efficiency saving of 92% is provided by Sector futures relative to the ETFs portfolio’s value¹. Looking between a portfolio based on equity swaps and one based on Sector futures, a similar conclusion can be reached (11.1%).

Based on the analysis completed, the trader notes that the CME Group Sector futures provide a more capital-efficient way to trade the same portfolio. This is one important factor in the overall decision of which access instrument to trade.

¹ ETF holders can find potential capital efficiencies via Reg T where a broker can extend credit on a position. However at least 50% of the position must remain fully funded, which when comparing an ETF portfolio obtained via Reg T with a sector futures portfolio would mean the sector futures portfolio is significantly more capital efficient.