A Beginner’s Guide to Futures
Trying to save people from losing all their money…
Disclaimer: I’m not an investment advisor, tax professional, or investment professional in any way. I’m a software engineer. Always consult an investment professional before making any decisions regarding anything discussed in this article. With that said, I do have a small trend following algorithm running and trading 24/7 the E-Mini Micro (MES) contract, so I have enough skin in the game, in my opinion, to know a little bit of what I’ll be discussing in this article.
Option Screener and The Wheel Screener are trader-friendly option screeners that analyze, classify, and categorize all options available on the market on a given day. The team is always more than happy to share their technical insights, market opinions, and methodologies here on Medium. This post is a bit different, where founder Chris talks about his recent learnings in the world of futures. We talk about what futures are, as well as how they are priced, named, and traded. We hope you enjoy the article!
Inform Yourself!
I wanted to write this article because I see massive trainwrecks forming in some of the beginner threads on Reddit and around the web at large about futures. I see a lot of people with zero clue about futures, the way they trade, and what they are, and they are way too impatient and just want to immediately start trading!
I do agree that all this finance stuff is often arcanely described or even obfuscated entirely for the average investor interested in learning more and getting started. However, it’s essential to understand a few basics before you end up behind a Wendy’s or something like that. That’s why I’ve decided to write up this beginner’s level article to distill what I’ve discovered in the past few months as I’ve entered futures world.
Pricing Structure
The very first thing you should understand about futures and how they differ from stocks is how they are priced. There are three main concepts to understand how various futures contracts are priced:
- Value per point. An increment of 1 on the contract. For the E-mini S&P, this is $50
- Tick size. For largely priced contracts, like the E-Mini S&P contract, The tick size is 0.25, that is it trades only in 25 cent increments.
- Tick cash value. This is where the absolutely mind-boggling, in my opinion, leverage comes in. To get the tick cash value, simply multiply the value per single point by the tick size, so in the case of ES, $50 x 0.25, or $12.50. This means that with a single tick change in E-Mini futures, you can gain or lose $12.50. Some traders like to think in terms of points only (i.e. 4 ticks) or just directly in ticks (like me! $12.50 per tick is more than enough)
Note that the ES future contract (or any future contract for that matter) is NOT like SPX, or SPY, or VOO where you can literally buy and sell shares at a given market price. Indeed, the concept of shares does not even exist in futures world. Rather, you are trading a contract that represents some sort of quantity in the real world (whether it be the value of the S&P, like ES, the value of a troy ounce of gold, like GC, or the interest rate value of a 2-year T-Bill, like ZT) that is then cash-settled to a dollar value.
With Great Power, Comes Great Responsibility
Yes, futures are insanely leveraged. When I learned about the pricing structure the first time for myself, I thought it was just stupid amounts of money. I still feel that way and hold a deep respect for these contracts.
If you have never bought or sold a stock or option in your life, let alone futures contracts, I think it would be wise for you first trade a stock or an option in very small amounts to get a feel for what trading is like. It’s not for everyone. Indeed, while you can make a lot of money trading futures, you can also lose it just as fast. Leverage is a double-edged sword.
Symbology & Nomenclature
Futures symbology is also annoyingly overcomplicated. You may see on sites like Twitter or Reddit people saying things like ES, /ES, #ES_F, or on places like TradingView even ES1!. Here’ s a breakdown of this symbology nonsense.
ES — the root symbol for the E-mini S&P futures contract. As we’re about to see, there are many variations on how you may see this shown
/ES —the thinkorswim way of referencing a futures contract. thinkorswim is a popular trading platform for trading through TD Ameritrade and it uses the slash (i.e. ‘/’) prefix for all futures so that they can have a distinction from stock tickers of the same (and thus conflicting) names
#ES_F — The common Twitter hashtag for ES. The ‘_F’ part means ‘front month’, i.e. This is just for lazy Twitter posters and users, that they don’t need to specifically think about or type in the current front month letter of the contract (we’ll get to what ‘front month’ is in a moment)
ES1! — The TradingView naming schema. They take the symbol, ES, then have either 1!, 2!, and so on to reference which month out to show. In this case 1! is the front month contract.
ESM3 — The symbol for the current front month of the S&P E-mini contract for t. This is the fully fledged, official symbol that you (should) see at the detailed level in any broker worth it’s salt. In this case, the M is for June, and the 3 for 2023.
The Concept of “Front Month”
The “front month” is the futures contract that is expiring first before any of the others for a given product. As mentioned, for ES, as of April 2023, that is the June contract. However, I could also go ahead and trade the Q3, or September contract, or the Q4, or December contract today. That’s one of the main uses behind futures: you can trade them to hedge against future unknown economic conditions.
Also, unless your a super smart genius hedge fund officionado, typically the front month is the only futures contract you care about. That’s anyway where 99% of the volume and price action occur. This may be slightly less true for some futures products, but those are largely the exception and are both beyond my knowledge and outside the scope of this post.
Expiration Month Symbology
So, why is M for June, you may ask? Well, the Chicago Mercantile Exchange Group, or CME Group for short, is the creator and issuer of these contracts. They have thought up just a fantastic way of denoting expiration months with these non-intuitive letters:
January: F
February: G
March: H
April: J
May: K
June: M
July: N
August: Q
September: U
October: V
November: X
December: Z
CME Group has a nice chart for this data which you can always use as reference:
Furthermore, in the case of ES, this future contract expires quarterly, that is, it changes, or “rolls over” at the end of each quarter. At the time this article was written, April 20th, 2023, which is in the 2nd quarter, the close of the quarter is in June. That means the front-month contract is the June, or ‘M’ contract. Combine that with the year number, 3, and we get our full ES symbol for the current front month: ESM3. Add ‘M’ to the front for the current micro ES symbol: MESM3. The next 2symbols for ES would be ESU3 (expiring at the end of Q3, September), and ESZ3 (expiring at the end of Q4, December).
However, please recognize that different futures contracts have different rollover months! They do not all follow the March / June / September / December structure like ES does.
I know, this stuff seems pretty annoying and complicated, but I recommend you just focus on one single product at a time and learn all about its ins and outs of rollover periods, tick size, and everything else discussed in this article. For me right now it’s the E-Mini Micro.
Brokers
You’ll need a broker to trade futures contracts. Unfortunately, you currently can’t YOLO into a 20 lot of ESM3 using your Robinhood app on your 4-year-old 1% battery Android.
There are a variety of quality futures brokers out there. It’s up to you to do your research and pick one you like. Most important to retail traders are likely the following:
- Commission / transaction / exchange fees — commissions can vary largely from broker to broker
- Look / feel of the platform (some people like bare bones, some people like lots of bells and whistles)
With that said, here are some I’ve heard anecdotally around the web, again do your research, and I’m not sponsored in any way by any of these:
- thinkorswim — technically here the platform is thinkorswim, and the broker is TD Ameritrade (now Charles Schwab) this is where many people begin as it has an excellent suite of indicators, and you can trade both futures and stocks all on the same platform
- Tradovate — nice minimalistic and clean UI, low comissions. I personally use Tradovate, as I found them because of their API functionality, but again, I’m not sponsored by them in any way
- Interactive Brokers, often alliterated as IB, they also have an API, but I’ve never used them or know how their platform is
- Know of some other good brokers? Leave a comment and I’ll add them to this list!
Taxes
In the United States, 60% of profits futures are taxed as long term, and 40% are taxed as short term, regardless of how long you hold, if you or short or long, or if you did a handstand while closing the trading. However, trading futures is anyway a rather advanced niche of trading and I would anyway suggest you get in touch with a tax advisor to see how the taxation works exactly at the end of each year.
Please, Trade Micros First
If you don’t take anything away from this article, please take away this: trade micros to start. I don’t care how smart you think you are, or if you’re the world's best trader, you’re going to feel sick when your first bad trade goes against you if you are trading even just 1 E-mini contract. I’m talking 500 dollars in 5 minutes kind of bad. So just trade a single micro to start. The E-mini micro is 1/10 the pricing scheme of the E-mini standard. So, please. Start with micros. I tried my best to warn you!
Thanks!
I hope this article cleared up most of the questions surrounding futures trading and you’ve got a better idea of how they are priced, traded, and named.
-Chris
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