Quarterly Outlook
Equity outlook: The high cost of global fragmentation for US portfolios
Charu Chanana
Chief Investment Strategist
You can access both of our platforms from a single Saxo account.
Options, futures or CFDs? How to trade equity indices, whether you’re a speculator or a hedger
Saxo
Summary: Many investors and traders seek out exposure to an equity index, such as Australia’s ASX 200 or the US’ Nasdaq Composite. Speculators can use leveraged derivatives to bet on a directional shift on the entire share market, while active investors can use these financial products to hedge existing share and ETF (exchange-traded fund) positions from adverse movements. Whether you trade index futures, CFDs, or options, Saxo has it all.
This analysis will assess your alternatives and help you decide what works best for your strategy.
What does it all mean?
Equity Index: a measurement of the performance of a public stock market represented in points. For example, the ASX 200 quantifies the success of the 200 largest listed companies in Australia.
Speculation: Trading with the purpose of making profits from the change in an asset’s price. Using derivatives and leverage, a trader will go long (buy low then sell high) or go short (sell high then buy low) with the intent to profit from the difference.
Hedging: An investment strategy with the purpose of protecting an existing portfolio from short-term market corrections or periods of high volatility. E.g., owning a diversified portfolio of US tech stocks and using a derivative to effectively hedge an adverse move in the index.
Index CFD: A Contract for Difference (CFD) is an over the counter (OTC) derivative product between an individual and a counterparty CFD provider (e.g., Saxo). The contract is an agreement to exchange the difference of an equity index’s point movement, from when the individual opens the contract and closes it. In exchange, the individual pays overnight financing to the CFD provider.
Index future: A derivative that offers leveraged exposure to the movement in an equity index. However, it is traded through a centralised clearing house or exchange (e.g., CME). Buying a futures contract means a trader is expecting the index to appreciate, and will look to sell that contract later for a profit. The selling counterparty, being another trader, is betting on an opposite movement. Index futures are cash settled, meaning that upon their quarterly expiration, any open positions will pay/receive the difference between the underlying index and the opening price of the contract. Unlike a CFD, index futures do not require overnight financing to be paid to a counterparty.
Index option: A derivative contract that gives the holder the right, but not the obligation, to pay/receive the cash difference between an underlying index and a predetermined price (the strike price) on a certain date in the future. Options are traded as either a call (the right to buy) or a put (the right to sell), giving market participants flexibility in building strategies and fixing risk. Index options are “European style,” meaning there is no risk of early assignment. They are also cash settled, which reduces capital requirements and risk of physical delivery.
What are we comparing?
Choosing which instrument is best suited for your portfolio and risk tolerance can be difficult, and is unique for everyone. For this analysis, we will examine two different stock indices - the Nasdaq 100 (the 100 largest public companies on the Nasdaq Exchange, primarily US tech firms), and the S&P 500 (the 500 largest listed companies in the US across all major exchanges). We will examine a speculative and hedging scenario to compare these different instruments.
Speculative trading: CFDs vs futures
For a trader looking to profit on the movement of a stock index, trading a CFD or index future allows for leveraged exposure to the underlying index. A trader will commit cash as “margin” to enter the position, and look to close the position on favourable terms for a profit. Should the position move against them, they will need to keep the margin level above the required amount (maintenance margin) to prevent liquidation, otherwise known as a margin call.
The example below compares a trader looking to profit from a movement in the Nasdaq 100. They want to expose themselves to 2x the index (at the time of writing, equivalent to just over USD 39,000), and hold the position for a month.
The CFD offers a capital-efficient option with a lower maintenance margin requirement, and has no exchange or brokerage fees. However, to hold the position for an extended period, this trade becomes incredibly expensive. The future, on the other hand, is a cheap contract to trade for the exact same amount of exposure, with no overnight interest paid. Futures are liquid, exchange-settled contracts that trade “24/5” and enable speculators to use technical indicators (such as volume) that CFDs do not offer.
A major difference between the two is the existence of an expiration date for futures contracts. A popular tool to maintain long-dated positions in these derivatives is called a futures roll, allowing the trader to maintain their position but enter the next quarterly contract, e.g., “rolling from June to September”. To learn more about futures trading at Saxo, follow the link here.
Hedging alternatives: CFDs vs options
Financial markets can be bumpy and unpredictable, so hedging your investments during times of high uncertainty and volatility can mitigate your losses and potentially prevent significant decreases in the nominal value of your long-term investments.
To paint a clearer picture of this comparison, the example below will follow an active investor that plans to hedge their existing US equity portfolio against a ‘market correction’ which they believe will occur in the next month. Moreover, instead of hedging individual shares or ETFs, this investor (let’s call him Jake) has decided that hedging against the S&P 500 is appropriate for him. Jake’s portfolio currently has a nominal value of USD 54,500, and he wishes to hold the hedge position(s) for 30 days. Here, Jake has two choices, among others, available to him:
- Short sell a CFD: If the market corrects and the S&P 500 falls, Jake will profit from the short position in the CFD, offsetting the losses on his equity portfolio. If the market does not correct, the profits from Jake’s equity portfolio will be reduced due to the open short position in the CFD contract.
- Buy a put option, otherwise known as a protective put: Jake can buy an “at the money” put option that, generally speaking, acts like insurance should the market move against him. The max Jake can lose on the option trade is the upfront premium they paid. If the market moves against their equity portfolio, they profit from holding the put option, as the contract will increase in value as it lands further ‘in the money’.
| Index CFD: US 500 (Short) | Index Option: S&P 500 Mini Index (XSP) (Long Put) |
Number of Contracts | 10 | 1 |
Index Value | 5,450 | 5,450 |
Position Size (Hedged Amount) | $54,500 | $54,500 |
Initial Margin | $2,725.00 | $0 |
Maintenance Margin | $1,362.50 | $0 |
Option Premium | $0 | $613 (30 DTE 5,450 Strike) |
Fee Breakdown (USD) | ||
Brokerage - Open | $0 | $2 |
Brokerage - Close | $0 | $2 |
Overnight Financing | $75.39 (1.66% pa) | $0 |
Total | $75.39 | $4 |
| Note (i): All figures are based on prices and interest rates from 25 June 2024. Note (ii): DTE = Days to expiration. A 5,450 strike sets the ‘price floor’. The portfolio is completely hedged should the S&P 500 move below 5,450 with the option profit offsetting the decline in the index at expiration. | ||
- Reduced profits if the market rallies: Any appreciation of the S&P 500 will not benefit Jake as he holds the short CFD position, which will cancel out all gains. The option, on the other hand, can expire worthless, allowing the portfolio to still profit from the market rally.
- Margin requirements and opportunity costs: the CFD trade requires USD 1,362.50 of margin to maintain the open position. This capital could be deployed into other investments instead of being used to hold a CFD position. The option, however, does not have this downside.
The protective put offers a more capital-efficient alternative with no margin requirement, cheaper brokerage, and greater flexibility. Constructing simple vertical option strategies such as put debit spread or call credit spread can also be a lucrative way to profit from adverse index movements. Check out these articles on option terminology and option trading to learn more.
Trading with Saxo
CFDs, options and futures are all effective methods to speculate and hedge equity indices. Saxo’s new pricing has made this even more affordable, with US futures trading from USD 1 and options from USD 0.75. Everyone’s risk tolerance and market objectives is different, so at Saxo, we always encourage rigorous research before making financial decisions.
Some of the most popular traded contracts at Saxo Australia (as of 27 June 2024) include:
Index CFDs:
- US SPX500 (US S&P 500)
- US Tech 100 NAS (Nasdaq 100)
- Australia 200 (S&P ASX 200)
- Germany 40 (Dax 40)
- US 30 Wall Street (Dow Jones Industrial Average)
Index futures:
- E-mini Nasdaq-100 (NQ) - Chicago Mercantile Exchange
- Micro E-mini S&P 500 (MES) - Chicago Mercantile Exchange
- E-mini S&P 500 (ES) - Chicago Mercantile Exchange
- Micro E-mini Nasdaq-100 (MNQ) - Chicago Mercantile Exchange
- ASX SPI 200 Index (AP) - Sydney Futures Exchange
Index options:
- S&P 500 index options (SPX / SPXW) - Chicago Board Options Exchange
- E-mini S&P 500 futures options (ES / ESW) - Chicago Mercantile Exchange
- Mini S&P 500 index options (XSP) - Chicago Board Options Exchange
- Micro E-mini S&P 500 futures options (MES) - Chicago Mercantile Exchange
- E-mini Nasdaq-100 futures options (NQ) - Chicago Mercantile Exchange
If you have any further questions, please do not hesitate to contact Saxo’s Sydney sales team on +61 2 8267 9000.
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