Emini’s, Risk and Leverage

As a followup to Dave’s explanation of how the emini contract works, I wanted to elaborate on the leverage and risk of the emini. One of the things that can be very confusing and intimidating to a new future trader is trying to figure out exactly how much leverage and risk they’re incurring by purchasing a future contract. In the case of the S&P 500 emini (ES), as Dave mentioned, the contract value is $50 per point, looking at my screen, the current Emini is trading at 1428, giving each contract has a value of $71,400.

Therefore, when you purchase one emini contract, what you’ve done is the equivalent of buying $71,400 worth of SPY or the proper amount of shares of each of the S&P 500 companies based on their index weighting to equal $71,400. Now how people get into trouble is when they fail to understand the magnitude of the difference between the actual contract value and the margin requirement at their broker. For example, I use Interactive Brokers and they only require $1750 per contract to hold it intraday. This means that on a single contract you are getting over 40x leverage, $71,400 / $1,750 = 40.1. Obviously this number bounces around as the price and value of the contract changes, but it’s safe to say the number is usually in the 35-45 range compared to the 4x allowed for intraday equity trades.

Now that we’re aware of the amount of leverage inherent in the contract we can determine how much leverage we want to use when actually trading. Suppose you are just getting started and ready to make your first emini trade and do not wish to use any leverage as you are still learning. All you need to do is allocate the full value of the contract (~$71,000) to your “emini trading” and trade only one contract. Don’t use any of that $71,000 for anything but your single emini contract and you will not be using any leverage. Your emini account will fluctuate by the exact same amount as if you were just buying the SPY (without margin) and you can get a good feel for how the eminis trade.

What I don’t recommend doing, especially for a new trader, is to use the margin requirement to determine your number of contracts. Assuming the same $71,000 allocated to emini trading, just using the margin requirement would allow you to buy 40 contracts, thus you’d be controlling the equivalent of ~$2.8 Million of SPY or S&P 500 stocks.

Here’s an example of what that type of leverage can do. Assume the $71,000 account is long 40 contracts and takes a 4 point loss (equivalent to ~0.3% and well under the daily ATR). That 4 point loss times $50 per point times 40 contracts is (4 * 50 * 40) $8,000. The account just lost over 10% of it’s value on a swing that probably took less then 15 minutes (less than 1 minute if there was big news). Assuming the same scenario with only trading a single contract, the account would have been down only $200 or ~0.3%, same as S&P 500.

In conclusion, the most important thing to remember is how much inherent leverage there is in each contract and that you must adjust your number of contracts traded based on the total value of the contracts, not the margin requirement supplied by your broker.

Feel free to comment or email (link in top left corner) with any questions.

- John