By Scott Bauer for CME Group
AT A GLANCE
- Options offer flexibility and are part of many strategies to manage market event risk
- Lower cost Micro E-mini options in the S&P 500 surged in volume as October earnings season arrived
Options can be useful in prepping for earnings season for a few reasons. They provide position and risk management flexibility, can limit downside risk, manage event risk and help to efficiently use capital. Market-neutral, directional or multi-leg trades can be used with several equity index options contracts. Since September, that has included the new Micro E-mini options on the E-mini S&P 500 and the E-mini Nasdaq 100.
These smaller-notional contracts provide greater versatility and granularity in helping traders manage event risk and navigate periods of volatility.
Nasdaq and S&P Exposure
Here are a few possibilities that a trader can use depending on their particular estimate of earnings:
If a trader owns E-mini S&P 500 futures and wants to hedge the position ahead of earnings, he could potentially buy puts or put spreads to hedge the position. A put option allows the owner the right to sell the underlying futures contract at the strike price. Additionally, if the trader wanted to take a bearish position in the S&P 500 index without owning the E-mini S&P 500 futures contract, he could purchase Micro E-mini S&P 500 put options at a fraction of the cost of purchasing S&P 500 E-mini options and without the exposure of simply shorting S&P 500 futures.
Another strategy to partially hedge a long S&P 500 futures position ahead of earnings would be to sell calls or sell call spreads. When you sell a call, you receive premium in exchange for being obligated to buy the futures contract at the strike price if the owner of the call option exercises his right. This is a common strategy (covered call), which is a short out-of-the money call against a long position in the underlying.
If a trader wants to have upside exposure to the Nasdaq he could purchase Micro E-mini Nasdaq 100 call options or call spreads ahead of earnings with the expectation of an overall rise in the index. The benefit to purchasing call options rather than purchasing E-mini Nasdaq futures is that they cost a fraction of the future itself and the risk is limited to the amount paid for the contract.
Earnings Season Surge
Micro options have shown great appeal since launching in late August. That’s not a surprise given their price of just 1/10 of the standard E-mini. Over 314,000 contracts traded across these indices through October 22, including 11 straight sessions of record volume in Micro E-mini S&P 500 options as we entered the heart of earnings season. They are based on an extremely liquid underlying futures market. Micro e-mini S&P 500 futures and Micro e-mini Nasdaq 100 futures traded a total of 291 million contracts through September.
Whether trading options on futures for purposes of hedging or speculating, a trader can define risk and reward using different option strategies. The new Micro E-mini option contracts allow traders to initiate identical strategies to E-mini option strategies but at a lower cost. That is a major development for active traders, and earnings season is proving to be a strong use case.