S&P Futures: Income or Wealth Generating Asset?

There are two ways to achieve the goal of capital appreciation. We can choose to trade the capital or invest it. And just as there are multiple ways to displace this capital, financial goals can be obtained using varying assets. 

It's important to understand that futures trading is an income-generating asset. Because all futures contracts expire, the standardized size of the contracts, excessive volatility increasing the risk, frequent losses, and the end-of-year mark-to-market tax rule are some of the things that make futures a better income-generating asset than wealth building. Wealth building requires time for capital appreciation to occur.    

Investing for wealth and trading for income must be distinguished to better plan for our financial well-being. Futures trading and Exchange-Traded Funds (ETF) offer opportunities for capital appreciation, but each is used in different capacities to achieve the desired results. 

This article intends to identify the advantages and disadvantages of each asset class. There are multiple futures markets and ETFs to trade, but for the context of this article, we will review the related products to participate in the S&P 500 stock index. 

General comparisons of the two 

Before identifying the differences between these, we should understand some commonalities between futures and ETFs. 

The S&P 500 is an index of 500 individual stocks representing large corporations throughout the US. Each stock price changes with buying and selling activity during the trading session. The value of the S&P 500 cash index updates as the prices change and a cumulative composite average is calculated for the index. Speculators/investors cannot trade the S&P 500 cash index, but tradable products correlated to it, like the futures markets and ETFs, were created to allow speculation. 

• Futures markets and ETFs will closely track the cash S&P index. 
• Both of these products trade on regulated US exchanges. 
• These products have day trading opportunities and multiple days of overnight trading. 
• Both can use leverage. 

As of December 23, 2022, the notional value of one micro S&P futures contract was $19,348.75. The notional value is derived by multiplying the last value traded for the micro S&P futures contract by its index point value of $5.00. In this case, the previous price traded on 12/23/22 was 3,869.75 index points. The last value traded is referred to as index points. Unlike physical commodities, stock indexes do not trade in dollars and cents. 

*Approximately 

Originally equity index funds were only traded through mutual funds, which had higher management fees and could only have trades executed once daily on the market close. Today, ETFs for index funds trade similarly to stocks by allowing transactions to be completed during the trading session and with much lower management fees. 

Another advantage of using ETFs for wealth building is that investors don't have to pay commissions on transactions anymore, unlike in the futures markets each contract traded is required a commission. More of the original investment goes to work instead of towards fees. 

ETFs, offer another advantage of buying odd lot sizes, allowing investors to adjust their risk by the number of shares purchased. Investors can dollar cost average over time by buying different size positions.

An advantage ETFs have over futures markets for investing is that they offer quarterly dividend payments, helping to increase portfolio value over time. ETF Investors can potentially build wealth with capital appreciation and dividend growth, whereas futures markets will only have capital appreciation. 

Wealth building using ETFs has another advantage of trading odd lot sizes. Investors can sometimes scale out of their core positions as the need for funds becomes available or for market timing purposes—the more shares owned, the more flexibility for this feature. 

Liquidity

In 2005 the SPLG ETF began trading; in 2019, the micro S&P futures contract began trading. Considering their infant stages, both of these assets have significant liquidity, allowing traders and investors the flexibility of entering and exiting trades with reduced slippage on transactions. 

Duration of holding period

Building wealth over time with less position maintenance is better with ETFs. If a buy-and-hold strategy is desired with futures, quarterly futures contract expirations will result in rolling-over positions as the contracts come to expirations. Resulting in more expenses for each new futures contract purchased. And the possible loss of value due to carry charges (expiring contracts are cheaper than the next contract bought) and could require time for the new contract price to catch up with the previous contract value you sold. 

Volatility = Risk 

Because of the futures market individual contract size, the dollar value of the portfolio becomes significant. Because of the extensive leverage a futures contract carries, the risk is exponential when it begins to go against you, reducing your holding period. ETFs' odd lot size purchases allow better risk management. First, you can only lose the amount purchased if you use a cash-only account to buy the ETFs. If you decide to build wealth with futures, every transaction is done using leverage and can result in losing more than you have in your account.   

Tax Considerations 

Futures have always had better tax benefits than equities for short-term trading (income generating.) All futures profits are taxed at 60/40; 60% are taxed at long-term capital gains and 40% at short-term capital gains. While ETFs held for less than one year will be taxed at short-term capital gains. However, wealth building will typically incur holding positions for longer than one year; therefore, the taxes would be the same for either vehicle used. 

Summary

Both futures and ETFs have their place in portfolios. But, the critical thing to remember is when and how to use each to get the most benefit. While preparing for the New Year, determine your financial goals and select the vehicle with the best returns and negligible expenses. 

The SPLG is similar to a micro futures contract because it trades at a smaller per-share value than its big brother, the SPY. Both of these are administered by SSGA, and the management fees are less with the SPLG.

The micro S&P futures contract has been outstanding since its inception regarding liquidity and international acceptance. Like other futures contracts, this one is best for income generation due to the shorter holding periods of positions. 

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