Watching and trading equity index spreads offers market participants useful insights into the equity market. Is one segment outperforming another? Are certain segments moving in tandem?
Learn how spreading small-cap index futures, such as the recently launched E-mini Russell 2000, versus large- and mid-cap index futures can help traders experience greater cost and capital efficiencies. Since E-mini Russell 2000 Index futures (RTY) launched on July 10, 2017, open interest (OI) has surpassed 500,000 contracts, making RTY another liquid tool in CME Group’s (CME)1 portfolio of U.S. equity index products.
The other US equity index futures available at CME are highly correlated with the E-mini Russell 2000 Index future and thus present spread trading opportunities.
|Correlation Between Russell 2000 Index and Other US Equity Indices|
|S&P MidCap 400||0.954|
|Dow Jones Industrial Average||0.749|
Source: Bloomberg Professional2
More than 2 million contracts are traded daily in CME’s equity markets; this liquidity allows clients to take advantage of these spread opportunities. Of the underlying constituents found within the Russell 2000 index and the indices listed in the table above, the only overlap can be found in the S&P 400 MidCap index. There is no overlap with the other indices. The S&P MidCap 400 index currently shares 158 constituent stocks with the Russell 20003.
Since just the second week of listing the E-mini Russell 2000 Index futures on CME, the market impact of executing either a 40-contract order or a 100-contract order has proven to be less on CME than on ICE4. Thus, investors can execute spread trades that include Russell 2000 Index futures more efficiently on CME.
For investors who are currently using exchange-traded funds (ETFs) to gain exposure to these indices and to execute spread trades, please reference a total cost analysis (TCA) on Russell 2000 futures and ETFs found on the CME website at cmegroup.com/russell2000tca
This report concludes that futures are the more cost effective product for most investment scenarios. Now that the E-mini Russell 2000 Index futures are on CME, these spread trades can potentially be more cost effectively executed via futures than ETFs, especially when the capital efficiencies related to margin are considered.
The return of E-mini Russell 2000 Index futures to CME has resulted in more capital-efficient trading than when the contract was available at a different exchange. Margin offsets, which can be enjoyed by trading two offsetting Equity Index future contracts at CME, enable this efficiency. Margin credits allow investors to manage positions more efficiently and decrease the friction incurred in trading, resulting in potentially more profitable spread trading. This, in turn, can add liquidity and further tighten the bid-offer found on the order book.
The potential margin savings can be seen from the table below:
|Leg 1||Leg 2||Ratio (Leg 1: Leg 2)||Margin Credit|
|RTY||ME (E-mini S&P MidCap 400)||4:1||80%|
|RTY||RS1 (E-mini Russell 1000)||5:6||75%|
|RTY||ES (E-mini S&P 500)||3:2||75%|
|RTY||YM (E-mini DJIA)||3:2||70%|
|RTY||NQ (E-mini NASDAQ 100)||3:2||65%|
Source: CME Clearing5
Assume an investor wishes to trade a spread that consists of long U.S. large-cap stocks vs. short U.S. small-cap stocks, which can be expressed by going long E-mini S&P 500 Index futures and shorting E-mini Russell 2000 Index futures.
|Name||CME code||Index Level||Contract Multiplier||Contract Notional||Margin Offset Ratio (vs ES)||Offset Percentage|
|E-mini S&P 500||ES||2500||$50||$125,000||N/A||N/A|
|E-mini Russell 2000||RTY||1450||$50||$72,500||3:2||75%|
|Name||CME code||Margin per Contract||Number of Contracts||Margin|
|E-mini S&P 500||ES||$4,500||2||$9,000|
|E-mini Russell 2000||RTY||$2,750||-3||$8,250|
|Offset @ 75%||$12,937.50|
The simplified contract ratio of 3:2 is a function of the notional values of the contracts and is therefore subject to change; the actual ratio of the notional amounts is likely to differ slightly from this simplified ratio.
If the investor trades this in a ratio of long 20 E-mini S&P 500 Index Futures contracts vs. short 34 E-mini Russell 2000 Index Futures contracts6, the invested notional would be $2,500,000 vs. $2,465,000 and the margin that would need to be posted for this spread trade at CME would be $54,1257.
If these positions were housed at two different exchanges, as was necessary before E-mini Russell 2000 Index Futures were available at CME, the initial margin required would be $164,8008. Thus, by trading both contracts on CME, an investor could experience a margin savings of $110,675 (67.2%).
The opportunity to spread trade also exists for options on futures contracts. The same rationale for capital and cost efficiency seen with CME’s equity futures suite, also exists for options on E-mini Russell 2000 Index futures spread against other CME Equity Index Options on Futures.
Learn more about CME’s E-mini Russell 2000 Index futures and options at cmegroup.com/russell2000
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