Popular demand has asked that I put together a quick piece about futures, specifically E-minis. You'll hear me talk about them from time to time. I trade them fairly actively as they are my preferred vehicle of choice for day trading and hedging.

If you don't know what a futures contract is, I would check the piece I wrote in my archives to get a feel for what they are. For a quick definition, they are an obligation to deliver or to receive a specified quantity and grade of a commodity during a designated month at the designated price. Each futures contract is standardized and specifies commodity, quality, quantity, delivery date and settlement.

There are futures contracts on various commodities and services, but I trade e-minis almost exclusively. Please don't confuse e-minis with Index futures. E-minis are scaled down contracts that are somewhat affordable; whereas full sized contracts have unbelievable sticker prices and margin requirements that makes it harder for the individual investor to actively engage in them.

E-minis closely follow the price movement of their underlying index. They are widely used by traders for portfolio protection as well as for speculation. The primary benefit that these contracts offer are tremendous leverage (up to 10:1), phenomenal liquidity, and longer market hours (nearly 24/5).

An E-mini contract is a legally binding agreement to buy or sell the cash value of the contract at a specific future date. More importantly, they are settled in cash. E-minis are also “marked-to-market” meaning margin accounts are adjusted daily to reflect profits and losses. If there is a net gain or loss on any given day, it is noted in the account at the end of the day. If gains accumulate, you can take the profits from your account. If losses take your account below the minimum “maintenance” margin requirement, your broker can close your positions and demand you send in more money to continue trading. You know, a margin call. You can also lose all of your margin—and more—if the market were to make an unexpected move against you and you had not put a safety net in place, such as a stop order.

Next, it is crucial to understand the leverage that is offered here. The minimum price movement of the E-mini contract is called a "tick". As an example, let's use the S&P contract (ES). The tick value is .25 index points, or $12.50 per contract. This means that if the futures contract moves the minimum price increment (one tick), say, from 1400.00 to 1400.25, a long position would be credited $12.50; a short position would be debited $12.50. Also, a one-point move (four ticks) is $50.00 per contract ($12.50 times four ticks). This means that if you enter a long position at 1400.00 and cover the position at 1410.00, $500 is credited to your account. Conversely, if the contract declines from 1400.00 to 1390.00, and you are long, you would have a $500 loss debited to your account.

Not all contracts trade at the same specs. I have included the contract specifications and margin requirements below...

E-Mini S&P 500 (ES)  
Margin: Initial- $3,938 Maintenance- $3,150 
Trade Unit $50 times the Standard & Poor's 500 Stock Index
Tick Size 0.25=$12.50

E-Mini Nasdaq 100 (NQ)  
Margin: Initial- $3,250 Maintenance- $2,600
Trade Unit $100 times the NASDAQ-100 Index
Tick Size: 0.25=$25.00

Mini-Dow Jones (CBOT) (YM)  
Margin: Initial- $3,125 Maintenance- $2,500 
Contract Size $5 times the Dow Jones Industrial Average Index
Tick Size  0.25=$1.75

E-Mini Russell 2000 Index (ER)  
Margin: Initial- $4,250 Maintenance- $3,400 
Trade Unit $100 times the Russell 2000 index price
Tick Size: 0.10=$10.00

What you have just read is what I consider "the hard stuff." The easy part is that the approach you use to trade them is constant. Technical analysis doesn't apply only to the markets that you are used to, it applies to all markets. However, I would highly recommend using a mechanical approach as opposed to a discretionary approach to trading futures. If you are a discretionary trader, and cope with emotional battles when trading options, futures isn't the best thing for you right now. Battle your demons first before you try and get over-leveraged. 

The next item I want to note is how sensitive these contracts are. If you are using them to hedge your portfolio, you might want to have an idea of how many deltas one contract will offer. Here is a snapshot...

If I were looking to use the S&P (ES) to hedge my portfolio, and I wanted to create a -500 delta position, I would have to short 10 contracts. Easy stuff, right?

In conclusion I want to mention that I use these vehicles to hedge and to daytrade. Nothing more, nothing less. How I trade them is similar to how I trade everything else...I look at price action from different time frames (for example, 15-minute charts for intraday analysis, hourly charts for near-term 1-2 day analysis, and daily charts for 1-2 weeks); I identify patterns, support and resistance levels, and where the prices are at relative to these levels. As I day trade I also look at volume intensity and watch for accumulation upon breakouts, and distribution upon breakdowns.

So that ought to do it. I imagine that the flood gates ill now open for Q&A, so I will try to monitor and chime in where I can help. I know papertrading isn't for everyone, but if you plan on trying is on for size, it is mandatory until you get a feel for things.

I'll be back later today to update you with my take on today's action.