Short-term speculators focused on futures markets for decades due to high commissions in traditional equity and bond markets.
Also, stocks and bonds were sold to the public as long-term investments while futures contracts gained a well-deserved reputation for wiping out family accounts, reports the Investopedia.
Given the high risk, investment professionals considered futures exposure unsuitable for all but the most sophisticated clients.
The tide turned in the 1990s with the advent of the Internet and low-cost trade execution that began at innovative brokers like e*Trade.
The nascent industry grew rapidly into the new millennium, spreading into futures brokers while institutions went to work creating new types of investment vehicles.
These included exchange-traded funds (ETF) that allowed traders and investors to access entire asset classes, rather than individual markets.
Fund creation spread into equity versions of popular futures contracts, allowing Main Street to fully access those contracts with less risk due to lower commissions and smaller sized positions than permitted in contract specifications.
Futures markets responded by creating smaller sized electronic versions of popular contracts, known as the e-minis, with the transition finally leading to the abandonment of most floor trading at CME Group, the largest futures venue in the world.
Four futures-based equity funds now dominate trading volume on US exchanges, with these instruments moving in lockstep with underlying futures contracts in real time.
Most track cash indices aligned with futures contracts, rather than the contracts themselves, due to complications in pricing the current value of different expiration dates.
This is known as roll risk, contango and backwardation.
These highly liquid instruments attract both retail and institutional participation, but big investment houses are more likely to take exposure in the futures contracts due to greater leverage.
Algorithmic trading programs dominate both venues, with buy and sell programs often erupting simultaneously.
THE 4 TOP EQUITY PROXIES
SPDR Trust (SPY) tracks a market cap weighted index tied to blue-chip components include nearly all top American companies, but the S&P 500 index committee can choose to exclude companies that otherwise fit capitalization requirements.
The fund can be utilized for short-term speculation or long-term investments as a replacement for traditional index-based mutual funds.
It’s also a popular day trading vehicle, with repeating price patterns that are easily observed down to the 1- and 2-minute charting intervals.
Its popularity tends to increase during periods of high risk and volatility, with institutions transitioning out of more speculative instruments.
It shows a five-year return of 14.20 per cent.
iShares Russell-2000 Index Fund (IWM) closely tracks the small cap index through a market cap weighted methodology.
It trades more than 37-million shares per day on average, making it the second most popular futures focused equity fund.
Its popularity has fallen steadily since 2011, in line with volume contraction in other index funds, due to a reduction of total US equity volume due to stock buybacks, merger activity, and privatization.
The fund tends to attract more speculative interest than the S&P 500 or Nasdaq-100 because it’s focused on small companies with high growth rates.
They’re also domestically oriented, making the instrument a natural beneficiary when the rising US Dollar (USD) adversely impacts profit at multinational corporations.
It shows a five-year return of 12.19 per cent.
Powershares QQQ Trust (QQQ) tracks a modified market cap index tied to the Nasdaq-100 futures contract.
The fund contains no financial stocks and skews heavily toward blue-chip technology companies, which comprise a 60 per cent weighting.
Popular single stocks, including Apple (AAPL), can exert a substantial influence on pricing due to the weighting methodology.
The fund trades 35-million shares per day on average in a tight bid/ask spread between 1 and 2-cents.
It often trades through higher percentage intraday swings than SPY due to its composition, as well as greater participation of short-term speculators.
Fund volume has fallen steadily from a 2009 peak, due to market-wide issues and the introduction of more exotic Nasdaq-100 derivative instruments.
It shows a five-year return of 18.26er cent.
The United States Oil Fund (USO) trades nearly 27-million shares per day on average, with speculators and investors seeking to profit from price swings in the NYMEX WTI crude oil futures contract.
It is constructed by holding near-term contracts, creating significant rollover risk generated when expiring instruments need to be sold for new forward dates.
Due to rollover mechanics, the fund can underperform the futures contract over time and is best utilized as a short-term speculative vehicle.
It carries a relatively high expense ratio at .66 per cent and currently shows a 5-year return of -16.67 per cent.
This is an exceptionally popular equity, holding nearly $2-billion in assets, with that number rising significantly since the 2014 crude oil collapse.
The Bottom Line
Futures markets now have equity proxies for nearly all major contracts, offering traders and investors a greater number of venues that match their risk tolerance and objectives.