Recent geopolitical tensions and significant advances in artificial intelligence have heightened market uncertainty and volatility. In particular, the technology sector has experienced extraordinary growth, outpacing other market segments and highlighting the need for adept navigation of market fluctuations. 

Sector indices allow investors to focus their exposure on specific areas of the economy as they are made up of industry-specific indices of stocks. We provide a robust suite of futures on 19 different sector indices, including the main 11 S&P Select Sectors, which allow investors to pinpoint their risk-management strategies to specific market segments of their choice – all the while benefiting from liquid markets, convenience of use and capital efficiencies through features such as derived block trading.

This article focuses on the sector-specific growth that has been seen over 2024 and the theoretical trading scenarios that may arise from the varying trends in different market sectors.

Figure 1 below shows the divergence among sector performance in 2024, highlighting varying trends across key market segments. Notably, the Technology and Financial Select Sectors have experienced pronounced movements in index levels, diverging from relatively stable sectors and broad indices like the S&P 500. The index levels illustrated in Figure 1 have been rebased with January = 100.

In addition to the divergence in sector performance, Figure 2 below illustrates historical three-month volatility trends across key market sectors. As observed, volatility trends have varied, with technology and consumer discretionary sectors displaying heightened fluctuations, particularly towards the beginning of Q4 2024, while others such as consumer staples and health care maintained lower volatility levels throughout the year. This heightened risk in certain sectors presents the need for investors to factor in volatility when evaluating sector-specific positions and hedging strategies.

In order to mitigate unfavorable movements that may result from this divergence in specific market sector performance, investors may look to hedge positions using futures on sector indices.

Our Select Sector futures average daily volumes (ADV) have climbed steadily over the past four +years, with ADV up 10% this year, and open interest (OI) currently sitting at around 256,000 lots for the entire suite.¹ As of October 10, 2024, the average daily value traded in the sector futures suite was $1.89B USD.

Leading the way in volume growth in 2024, the Dow Jones U.S. Real Estate Index futures are up 28% in ADV this year followed by S&P consumer staples and financial Select Sectors which are up 17% and 13% in ADV this year respectively.² Useful trading functionalities and capital efficiencies further drive their adoption by market participants for hedging or speculative needs.

When trading futures on Sector indices, investors can enjoy the benefits of liquid, around-the-clock trading via CME Globex or enjoy other trading features such as block trading, Basis Trade at Close (BTIC) or derived block trading – a convenient trading mechanism which helps mitigate risk in block trades.

Market participants entering large positions can benefit from derived block trade functionality, which permits traders to access the liquidity found in adjacent markets such as cash baskets or ETFs. 

When executing a derived block trade, parties agree to a notional value or number of contracts for the trade, as well as the market to be used in establishing the hedging position. Four pre-defined hedging methods are allowed: time weighted average price (TWAP), volume weighted average price (VWAP), percentage of volume and limit price, which determine the value of the hedging basket. Hedging baskets include instruments such as ETFs, ETNs or other cash market products, which allow for greater flexibility in porting in liquidity from the cash market.

Underlining the popularity in derived block functionality, trends show that derived block trading is growing significantly since launch, with a cumulative notional of over $61B traded so far.

Using our Sector futures, investors can establish sector-specific hedging positions while taking advantage of capital efficiencies through the lower margin requirements in comparison to fully funded instruments such as cash baskets or ETFs. Clients also benefit from other advantages seen with futures such as zero management fees, potential margin offsets on sector vs. sector/index trades and potential efficient tax treatment. Hedging using futures also ensures an accurate tracking of an index, eliminating the operational risk of error when manually tracking an index via cash baskets.

The tech sector has experienced extraordinary gains this year, outpacing other market segments and highlighting the need for adept navigation of market fluctuations. Markets are also swaying to sentiment on when the Federal Reserve will cut interest rates and by how much in the wake of ebbing inflation and the labor market softening. The tech sector, in particular, was recently impacted by investors switching from mega caps to smaller companies as part of a sector rotation, although the intensity of that process has slowed down.

Continued development in artificial intelligence (AI) has fueled the recent growth in the technology sector. Since the start of 2023, the S&P Technology Select Sector has grown 81% compared to the S&P 500, which grew 48% during the same period.³

The technology sector has also seen more pronounced price movements when compared to the overall market. A large dip in the market observed between July 5, 2024, and August 5, 2024, led mainly by large technology companies' disappointing earnings calls, saw the S&P Technology Select Sector dip 15% while the S&P 500 had a more modest dip of 7%. The 2x difference in the magnitude of the recent drawdown highlights the technology sector’s sensitivity to current market trends and provides opportunities for a directional trade.

Investors looking to capitalize on heightened sector movements may go long an S&P Technology Select Sector futures contract to capture greater returns compared to a broader index, while those with significant exposure in the technology sector may seek to hedge against adverse movements in order to better risk manage their portfolio.

For example, assume that an investor believes that the technology sector is overpriced on June 12, 2024, with the S&P Technology Select Sector September 2024 contract (XAKU4) trading at 2,293. Concerned that the market will correct in the coming months as earnings calls are released, the investor decides to enter a short position on 10 Technology Select Sector September 2024 contracts (XAKU4). With a multiplier of $100, this means each index point movement equates to $100 per contract.

As the investor had anticipated, the technology sector experienced a pullback, and on August 12, the futures contracts (XAKU4) fell to 2,099. The investor decides the price level is appropriate and closes out of their position. The short position, entered at 2,293 and exited at 2,099, results in a profit of 194 index points per contract.

By shorting 10 contracts and exiting the market while it was in a slump, the investor capitalized on their belief that the technology sector was overvalued, resulting in a profit of $194,000. The direct exposure to the technology sector allowed the investor to capitalize on the greater magnitude of price movements within the sector.

Another possible trading strategy using futures on Sector Indices is trading relative value between two sectors. Investors may trade relative performance differences between sectors by going long on one and short the other. For example, suppose that heading into Q3 2024, an investor believes that financials will outperform energy, possibly due to improving economic conditions and promising banking sector performance. The investor decides to go long on financials and short energy to capture the spread using Sector futures.

On August 1, 2024, the investor initiates the following positions:

• Long: 80 S&P Financial Select Sector September 2024 contracts (XAFU4) at 532

• Short: 111 S&P Energy Select Sector September 2024 contracts (XAEU4) at 954

To maintain value neutrality, the trader adjusted to 80 contracts on Financials and 111 contracts on Energy, reflecting a balanced notional value of each sector position.

By September 3, 2024, the financial sector rose to 559, and the energy sector declined to 931, aligning with the original views of the investor.

The hypothetical payout in this relative-value trade is as follows:

The relative value trade between the financials and energy sectors demonstrates how investors can capitalize on the performance disparity between two sectors. By going long on financials and short on energy, the investor captures gains from both the upward momentum in the financial sector and the downward trend in the energy sector. The hypothetical strategy yielded a total profit of $795,300, displaying the potential benefits of sector spread trading. This approach using futures on sectors allows investors to fine-tune leveraged market exposure, offering a flexible and targeted method to navigate market conditions.

Our Sector Index futures date back two decades and continue to innovate new, related products and functionalities over the years. The ever-changing trends in market sectors highlight the importance of managing sector-specific risk and direction as markets continue to evolve through 2024. Launched October 2024, we list options on Dow Jones U.S. Real Estate Index, S&P Industrial, Energy, Financial, Health Care, Technology and Utilities Select Sector futures.

• Sector futures enable flexible strategies, such as relative value trades or capturing sector price movements.

• Their potential margin offsets and convenient use are favorable when compared to fully funded instruments such as ETFs.

• Derived block trading functionality enhances liquidity, further improving execution and capital efficiency for institutional traders.

• As demand for sector-specific strategies grows, we continue to innovate the sector futures suite with new contracts further enabling investors to trade in unique ways.

Explore more about Sector Index futures and options specifications.

1.  As of 9/23/24
2. As of 10/10/2024
3. As of 10/10/2024

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