CME Takes ETFs Into The Future(s)

May 08, 2005

In a move targeted at individual investors, CME launches futures contracts on the SPY, IWM and QQQQ.

The Chicago Mercantile Exchange (CME) made a bold bid for the individual investor today by rolling out futures contracts on three popular exchange-traded funds: the Standard and Poor's Depository Receipts 1 (SPY, or "Spider"), the iShares Russell 2000 Index Fund (IWM) and the Nasdaq 100 Index Tracking Stock (QQQQ).

The products are designed to provide "sophisticated individual investors" an entrée into the wonderful world of futures trading by lowering the dollar amount required to purchase a futures contract.

"With today's announcement, we are bringing together two of the most successful financial product innovations in the last decade, the CME E-mini stock index futures and ETFs," said CME Chairman Terry Duffy, in a statement.

A New Market for CME

The futures industry has long been an institutional-only investing arena. With the huge leverage offered by futures contracts and the huge dollar amounts involved, the sign outside the door reads: "Individual investors need not apply."[1] 

What's so interesting about these new ETF contracts, however, is that they are specifically designed for individual investors.  As such, their launch suggests that the CME is targeting these investors as a new growth area.  The company said as much in its press release:

"With the addition of our new ETF futures … we believe we will be able to attract more new customers - particularly sophisticated retail equity investors -- to CME," said CEO Craig Donohue.

But will they?

What Is an ETF Future and Why Should You Care?

For those unfamiliar with the futures industry, understanding where these products fit into the financial toolbox can be daunting. After all, CME already offers futures and E-Mini futures contracts on the indexes underlying these ETFS - the S&P 500, Russell 2000 and NASDAQ 100.  With deeply liquid futures contracts available on these indexes, you might wonder why anyone would bother with the new ETF futures.

The answer is that ETF futures differ from straight index futures in two important ways.

First, they cost less to buy.

Pricing is the key advantage of ETF futures.  Like a company that splits its stock to make it easier for individual investors to buy round lots (100 shares), ETF futures are designed to be easier for individuals to afford.

With the introduction of ETF futures, investors now have three futures contracts providing exposure to the S&P 500: a regular S&P 500 Index future, an E-Mini S&P 500 Index future and a SPY ETF future.

One regular contract on the S&P 500 Index costs $250 multiplied by the value of the index - about $300,000 based on current prices.

One E-Mini contract costs $50 multiplied by the value of the index - about $60,000 at today's prices.

The new SPY future only costs 100 times the value of the SPY - about $11,600 at current prices.

That's a huge difference for investors of (relatively) limited means.

CME has had success lowering the cost of its contracts before.  The original S&P 500 futures contract was worth $500 times the value of the index.  When the index hit 1,000 and that contract cost half-a-million bucks, CME cut the value in half to make it more affordable.

The E-Mini contract was introduced in the late 1990s to lower the bar even further, to allow hedge funds and other "smaller" institutional investors access to futures. Today, the E-Mini S&P contract is the most actively traded futures contract in the world.

The SPY future is just the latest step in this ladder.

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