Exchange innovation of the year: CME Group

The bull market in equities, now in its twelfth year, has been a boon to investors large and small. But while the dramatic rise in the S&P 500 from its post-crisis lows has been good news for Main Street investors, those using CME Group’s E-mini futures to gain or hedge exposure to US blue-chips faced a growing problem: gains in the underlying equities have been accompanied by a steady rise in margins required to trade the contracts, putting them out of reach for many.

The solution? A new ‘micro’ E-mini future a tenth the size of its bigger brother. The result: the most successful product launch in CME’s 170-year history.

On their first day of trading, May 6, 2019, CME’s four new futures – on the S&P 500, Nasdaq 100, Russell 2000 and Dow Jones Industrial Average – reached 310,000 trades. Since launch, they’ve racked up more than 72 million trades through the end of October, averaging 562,000 a day, with several million-plus days and a high-water mark of 1.4 million contracts on August 7. 

CME’s sizing of the micros was deliberate. Apart from making the contracts more affordable to its existing customer base, the bourse has been looking to grow the share of flows it gets from retail investors in recent years, with 27% of its volumes coming from this contingent in 2018.

“We are getting traders who have not been previously engaged in the futures market using the contracts,” says JB Mackenzie, managing director of futures and foreign exchange at TD Ameritrade. “It allows them to do a much better job of hedging their risk. Our retail traders have been highly engaged in using the micros, both the S&P and the Nasdaq.”

Back in the mid-90s, when CME introduced its E-mini contracts on the S&P 500 and the Nasdaq 100, the notional value of the contracts was about $50,000. Their launch coincided with a boom in electronic trading driven by the launch of equity index futures on CME’s Globex platform; over time, the contracts have ballooned in value to $150,000.

As contract values increased, so did their required margins. The traditional E-mini contract at $150,000 has an initial margin of approximately 5%, or $7,500, a level retail brokers say makes popular trading strategies too costly. For example, investors trading the standard Nasdaq E-mini futures against positions in the underlying Faang stocks – Facebook, Amazon, Apple, Netflix, Google – found themselves liquidating their futures positions to free up margin to purchase stocks.

“We were inadvertently forcing participants to make an either/or decision between the futures market and the cash equities market,” says Tim McCourt, global head of equity index and alternative investment products at CME. “Just as a function of the passive rise in contract value, we were forcing people to leave our markets.”

At one-tenth the size, the Micro E-mini has a notional value of some $15,000, requiring only about $750 in initial margin to trade. This makes it more accessible to individual traders looking to take advantage of the more favourable tax treatment of gains on futures contracts versus cash equities.

Just as a function of the passive rise in contract value, we were forcing people to leave our markets

Tim McCourt,CME

The smaller-sized contract also allows bigger market participants such as commodity trading advisers (CTAs) and hedge funds to manage their risk in a more granular way. Firms with a managed account or omnibus structure can now allocate positions across accounts in $15,000 increments, rather than chunkier blocks of $150,000.

The bourse has also seen interest from options trading firms looking to hedge their delta exposures, says McCourt: “The smaller contracts have attracted institutions because they can be much more precise when managing their risks.”

During 2018 and early 2019, CME honed the products’ design, consulting with customers on the optimum tick sizes and trading rules. It had to get the balance right: too big, and retail punters would be shut out of trading; too small, and the contract would become too costly for liquidity providers looking to offset positions held in the E-mini.

Concerns over the micros cannibalising the liquidity of E-minis have proven unfounded. Through the end of October, the average clip size, or quantity per order, of the Micro E-mini is roughly 2.7 contracts – well below the 10 lots seen on the E-mini, a level that hasn’t diminished since the micros started trading.

Trades on the Nasdaq 100 make up about 35% of the flow of micro contracts, versus 25% of standard E-minis on those four indexes, suggesting individual traders, seeking to replicate Nasdaq’s performance, are embracing the new product.

“Launching new products and developing new markets is not an easy task,” says McCourt. “We were conscious of making sure we didn’t cannibalise the flow from the E-mini. But given the demand and the thesis that there are people who don’t want to trade in whole E-mini lot sizes, we were comfortable it wouldn’t happen and we haven’t seen it to date.”