Learn what E-Minis are, how they work, and what their pros and cons are.
Definition and Example of an E-Mini
An E-Mini is a futures contract that is 20% of the size of a typical futures contract. The “E” in the name stands for electronic, meaning they are primarily traded electronically. Among the most popular is the S&P 500 E-Mini, which is based on the S&P 500 index. These contracts are agreements between buyers and sellers to exchange money based on the value of the S&P 500 stock index. The contract size is equal to $50 multiplied by the S&P 500 index. For example, if the S&P 500 is at 4,000 points, the value of one E-Mini contract would be $200,000 ($50 x 4,000). E-Minis are now available for other stock indexes, such as the Russell 2000 and Dow. There are also Micro E-Minis, which are half the size of a normal E-Mini.
How Does an E-Mini Work?
E-Minis are a type of futures contract, so they work like futures. When you enter into a futures contract, you’re agreeing to buy or sell an asset for a predetermined price on the agreed-upon date. Unlike commodity futures, which involve the actual delivery of things, such as grain or oil, index futures are cash-settled. When the time for delivery arrives, the two parties to the contract simply exchange cash to settle the transaction. Typically, investors instead close out their positions by opening an equivalent but opposite position. For example, if you sell one E-Mini, you can close your position by buying one of the same E-Mini. You profit or lose money based on the prices at which you bought and sold the contracts. One reason E-Minis are popular is that they let you use leverage to gain control over a much larger amount of money than your account’s balance would typically allow. Another reason they’re popular is that they make futures contracts more accessible. You can also use an E-Mini to hedge against drops in the stock market. By selling an E-Mini, you can profit when the S&P drops and the leverage involved means your gains will be relatively greater than the drop in the index’s value. At the same time, your losses will be amplified if the index rises in this scenario, so there is risk involved.
Pros and Cons of an E-Mini
Pros Explained
Leverage increases potential gains: Like most derivatives, E-Minis involve leverage. When you borrow money to invest, you’re amplifying your potential gains. Highly liquid market: E-Minis are traded almost 24 hours a day, making it easy for investors to open and close positions at any time.
Cons Explained
Leverage also increases potential losses: While leverage amplifies gains, it also increases risk. If the S&P 500 drops in value, you could potentially lose more than you invested in your S&P 500 E-Mini, leaving you in debt to your broker.Futures can be highly complex: Futures are highly complex securities. The way they are priced and traded can be difficult for new investors to understand. When trading with leverage, it’s essential to make sure you know what you’re doing, so beginners should avoid E-Minis.
What It Means for Individual Investors
E-Minis and other futures are complicated and can be highly risky. Most investors should probably avoid them. If you want to get involved with derivatives, including those tied to an index such as the S&P 500, options are a popular method to use. They’re less complex and still give you a way to leverage a portfolio and bet on your predictions about a stock or ETF’s future price movement.
