Trading Financial Indexes
- and the Rollover Spread Strategy
Trading Financial Indexes and the Rollover Spread Strategy
Stocks and bonds aren't the sort of thing the novice investor typically thinks of as a commodity. Even less do they view a statistical measurement of changes in their prices as similar to gold, wheat or oil. Yet, because stocks and bonds (and the indexes that measure price changes) trade in the form of futures and options contracts, they can be traded in the same way as other commodities.
While oil remains the most traded physical commodity, the financial futures market today is the largest for all contracts traded. One of the most popular is the contract for the Standard and Poor's 500 Index, the S&P 500.
As the, so to speak, gold standard of indexes the S&P gives traders a broad view of the stock market as a whole. The companies contained in the S&P 500 represent 80% of the entire market capitalization - the top 40 stocks in the S&P 500 represent 50% of its total.
That means traders can be confident that there will be no liquidity problems, as sometimes happens with some other commodities.
It also means risk is easier to assess. The tools available to measure and predict the S&P 500 are more reliable, since predicting stock prices is much easier than that of commodities. Easier, but definitely not easy. Just as one example, the stocks in the S&P 500 have reliably offered the highest return over a 30 year period of any investment, around 12% depending on the range selected.
Stock prices can definitely be volatile, and large single-day price drops have happened several times. But indexes typically, by design, move less far and less rapidly than other prices. The idea of using a broad based index is precisely to smooth out the bumps of individual stocks, in order to assess the direction of the market as a whole.
Yet, along with reduced risk and better predictability, traders still enjoy the other advantages attendant on using futures and options as trading vehicles. Margin percentages are in the 5-7% range, so high leverage is still available, as it is with other commodities futures and options contracts.
The 'Rollover' Spread Strategy
Commodities trading is often very short-term oriented, with day trading the norm. Yet with index trading, investors can take advantage of those sharp swings, yet still take a long-term horizon view, as they would with ordinary stock investing.
For example, one common trading strategy is the 'rollover'. This technique allows traders to take a long position on a futures contract, then - as expiration nears - transfer the position to another contract with an expiration date farther out into the future.
This 'spread' strategy makes it possible to take advantage of price differentials and low commissions, while controlling the liquidation date. It's executed when traders predict that prices will soon move in the preferred direction, where 'soon' is just beyond the expiration date.
S&P Index futures are traded on the CME (Chicago Mercantile Exchange), and there's even an S&P 500 'E-mini' contract available, which carries a smaller commitment - one-fifth the standard contract. The trade unit is $50 time the S&P 500 Index. The trade unit for the standard contract is $250 times the S&P 500. In addition, since it trades all electronically, with no open outcry or pit trading, trading hours are almost around the clock.
For current prices and contract specifics, see the CME website.