CME: E-Mini S&P (
ES1!
), E-Mini Nasdaq (
NQ1!
)
Stock investors around the world had a banner year in 2023. Of the ten major stock market indexes I monitor, eight delivered solid 1-year returns.
• North America: S&P 500, +23.9%; Nasdaq Composite, +53.6%;
• South America: Bovespa (Brazil), +22.3%;
• Europe: FTSE (UK), +3.0%; Stoxx (Germany), +11.3%;
• Asia: Nikkei (Japan), +28.2%; Kospi (Korea), +18.7%; Nifty (India), +19.5%;
• China: SSE (Shanghai), -3.2%; Hang Seng (HK), -13.7%.
In this second installment of new year outlook for major asset classes, I will discuss what opportunities may lay ahead for US stocks. Subsequent writings will cover Energy, Agricultural commodities, Interest Rates, Forex, and Cryptocurrencies.
FYI: The last writing was a year-end review for metal commodities – Gold, Copper, and Aluminum. If you haven’t read it yet, you may follow the link here:
https://www.tradingview.com/chart/GC1!/Lnm0zHT0-Metal-Commodities-Year-End-Review/
Record Gains Built from Lower Baselines
While all four major US stock indexes booked double-digit returns in 2023, they each experienced a steep loss in 2022. The combined 2022-2023 returns aren’t so impressive.
• Dow Jones: +5.3%
• S&P 500: +3.3%
• Nasdaq 100: +9.3%
• Russell 2000: -5.9%
You may think that adding the 2022 return of -18.1 and 2023 return of 23.9% will give the S&P a 2-year return of +5.8%. But the actual return is only +3.3%. Why?
Simple Math: If you lose 20% first, you will need to gain 25% to make up for the loss and just get back to square one. Mathematically, 1/0.8 = 1.25, or (1-20%) * (1+25%) = 1.
This matters a lot to hedge funds. An active manager may have a 2-20 arrangement with his investors, which is 2% fee on asset-under-management, and 20% on carry interest. If a fund closely tracks the Nasdaq, the manager received no carry for 2022, and the carry for 2023 is based on the 2-year return of +9.3%, not the 2023 return of 53.6%. The fund usually would have a “high water mark” clause that requires the manager to make up for prior loss before getting paid. Therefore, Wall Street bonuses may not be that big this year.
2024 Outlook for US Equities
The December 26th CFTC Commitments of Traders report (COT) shows that:
• E-Mini Dow: “Asset Manager” has 26,070 long positions and 3,098 short positions.
• E-Mini S&P 500: Asset Manager has 1,147,149 longs and 275,037shorts.
• E-Mini Nasdaq 100: Asset Manager has 111,046 longs and 20,662 shorts.
• E-Mini Russell 2000: Asset Manager 229,229 longs and 142,312 shorts.
The overwhelmingly Net Long positions on all major US index futures indicate that futures traders are very bullish on US equities. Investors eye in a soft landing for the US economy and expect aggressive rate cuts by the Federal Reserve.
According to CME Group’s FedWatch Tool, the first rate-cut could occur at the March 20th Fed meeting, with a 73.5% probability. For June 12th, the odds of two or more rate cuts increase to 82.2%. By December 18th, investors expect the Fed Funds rate will be 1% to 2% lower than the current 5.25-5.50% range, with 98.5% odds (Data as of January 1st).
(Link: www.cmegroup.com/mar...e-fedwatch-tool.html)
US equity indexes could stay high as long as the Fed remains dovish. The past few months proved that investors are very resilient. The bullish market sentiment is very hard to break, unless really bad things happen.
If an investor owns US stocks, there is no good reason to sell them now. We have seen that geopolitical risks had done little damage to US equities. Fed policy still drives the market. Staying with the ride and hedging the stock portfolio with put options may be a good strategy.
Trading with CME E-Mini Equity Index Put Options
As US equity indexes take turn making all-time high, it’s costly to buy the underlying stocks. Options are an inexpensive alternative to get exposure in stocks. Depending your stock portfolio and views, you could either long or short the options on E-Mini S&P 500 futures
• Last Friday, the March E-Mini S&P 500 futures (ESH4) was settled at 4,812.75. Buying 1 long or short position requires initial margins of $11,800;
• January end-of-the-month (EOM) Call options with a 4910-strike costed 23.50 points. Premium for 1 call is $1,175 (= 23.5 x $50 multiplier);
• January EOM Put options with a 4710-strike priced at 27 points. Premium for 1 put is $1,350 (= 27 x 50).
We could construct a similar strategy with E-Mini Nasdaq 100.
• Last Friday, the March E-Mini Nasdaq futures (NQH4) was settled at 17,003.75. Buying 1 long or short position requires initial margins of $17,700;
• January end-of-the-month (EOM) Call options with a 17,200-strike costed 208.50 points. Premium for 1 call is $4,170 (= 208.50 x $20 multiplier);
• January EOM Put options with a 16500-strike priced at 127.70 points. Premium for 1 put is $2,551.40 (= 127.75 x 20).
In a rising market, out-of-the-money put options could be a strategy for small odds with big payoff. In January, we will have new data releases for December inflation (CPI and PCE) and nonfarm payroll employment, as well as a Fed meeting on January 31st.
My reasoning: If we see inflation rebound, stronger employment, or a hawkish Fed, the stock market could turn south, resulting in a gain for the put.
Hypothetically, if the March S&P futures price drops 150 points by January month-end options expiration, the put would be 47.25 points in-the-money (= 4710 – 4,662.75) and earn $2,362.5 (= 47.25 x $50). Using the initial margin as cost base calculations, the theoretical return would be 75% (= 2362.5 / 1350 - 1).
If the March Nasdaq drops 800 points (17,003.75-800=16,203.75) at January options expiration, the put would be 296.25 points in-the-money (= 16,500 – 16,203.75) and earn $5,925 (= 296.25 x $20). The theoretical return would be 132% (= 5925 / 2551.4 - 1).
On the other hand, if stocks continue to rise, put options will lose money, but never go beyond the premium already paid.
Options Calculator is a free tool CME Group provided for options traders. It generates fair value prices and Greeks for any of CME Group’s options on futures contracts or price up a generic option with this universal calculator. Traders could customize their input parameters by strike, option type, underlying futures price, volatility, days to expiration (DTE), rate, and choose from 8 different pricing models including Black Scholes.
www.cmegroup.com/too...ions-calculator.html
Happy Trading.
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Group Real-time Market Data help identify trading set-ups and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com/cme/
ES1!
), E-Mini Nasdaq (
NQ1!
) Stock investors around the world had a banner year in 2023. Of the ten major stock market indexes I monitor, eight delivered solid 1-year returns.
• North America: S&P 500, +23.9%; Nasdaq Composite, +53.6%;
• South America: Bovespa (Brazil), +22.3%;
• Europe: FTSE (UK), +3.0%; Stoxx (Germany), +11.3%;
• Asia: Nikkei (Japan), +28.2%; Kospi (Korea), +18.7%; Nifty (India), +19.5%;
• China: SSE (Shanghai), -3.2%; Hang Seng (HK), -13.7%.
In this second installment of new year outlook for major asset classes, I will discuss what opportunities may lay ahead for US stocks. Subsequent writings will cover Energy, Agricultural commodities, Interest Rates, Forex, and Cryptocurrencies.
FYI: The last writing was a year-end review for metal commodities – Gold, Copper, and Aluminum. If you haven’t read it yet, you may follow the link here:
Record Gains Built from Lower Baselines
While all four major US stock indexes booked double-digit returns in 2023, they each experienced a steep loss in 2022. The combined 2022-2023 returns aren’t so impressive.
• Dow Jones: +5.3%
• S&P 500: +3.3%
• Nasdaq 100: +9.3%
• Russell 2000: -5.9%
You may think that adding the 2022 return of -18.1 and 2023 return of 23.9% will give the S&P a 2-year return of +5.8%. But the actual return is only +3.3%. Why?
Simple Math: If you lose 20% first, you will need to gain 25% to make up for the loss and just get back to square one. Mathematically, 1/0.8 = 1.25, or (1-20%) * (1+25%) = 1.
This matters a lot to hedge funds. An active manager may have a 2-20 arrangement with his investors, which is 2% fee on asset-under-management, and 20% on carry interest. If a fund closely tracks the Nasdaq, the manager received no carry for 2022, and the carry for 2023 is based on the 2-year return of +9.3%, not the 2023 return of 53.6%. The fund usually would have a “high water mark” clause that requires the manager to make up for prior loss before getting paid. Therefore, Wall Street bonuses may not be that big this year.
2024 Outlook for US Equities
The December 26th CFTC Commitments of Traders report (COT) shows that:
• E-Mini Dow: “Asset Manager” has 26,070 long positions and 3,098 short positions.
• E-Mini S&P 500: Asset Manager has 1,147,149 longs and 275,037shorts.
• E-Mini Nasdaq 100: Asset Manager has 111,046 longs and 20,662 shorts.
• E-Mini Russell 2000: Asset Manager 229,229 longs and 142,312 shorts.
The overwhelmingly Net Long positions on all major US index futures indicate that futures traders are very bullish on US equities. Investors eye in a soft landing for the US economy and expect aggressive rate cuts by the Federal Reserve.
According to CME Group’s FedWatch Tool, the first rate-cut could occur at the March 20th Fed meeting, with a 73.5% probability. For June 12th, the odds of two or more rate cuts increase to 82.2%. By December 18th, investors expect the Fed Funds rate will be 1% to 2% lower than the current 5.25-5.50% range, with 98.5% odds (Data as of January 1st).
(Link: www.cmegroup.com/mar...e-fedwatch-tool.html)
US equity indexes could stay high as long as the Fed remains dovish. The past few months proved that investors are very resilient. The bullish market sentiment is very hard to break, unless really bad things happen.
If an investor owns US stocks, there is no good reason to sell them now. We have seen that geopolitical risks had done little damage to US equities. Fed policy still drives the market. Staying with the ride and hedging the stock portfolio with put options may be a good strategy.
Trading with CME E-Mini Equity Index Put Options
As US equity indexes take turn making all-time high, it’s costly to buy the underlying stocks. Options are an inexpensive alternative to get exposure in stocks. Depending your stock portfolio and views, you could either long or short the options on E-Mini S&P 500 futures
• Last Friday, the March E-Mini S&P 500 futures (ESH4) was settled at 4,812.75. Buying 1 long or short position requires initial margins of $11,800;
• January end-of-the-month (EOM) Call options with a 4910-strike costed 23.50 points. Premium for 1 call is $1,175 (= 23.5 x $50 multiplier);
• January EOM Put options with a 4710-strike priced at 27 points. Premium for 1 put is $1,350 (= 27 x 50).
We could construct a similar strategy with E-Mini Nasdaq 100.
• Last Friday, the March E-Mini Nasdaq futures (NQH4) was settled at 17,003.75. Buying 1 long or short position requires initial margins of $17,700;
• January end-of-the-month (EOM) Call options with a 17,200-strike costed 208.50 points. Premium for 1 call is $4,170 (= 208.50 x $20 multiplier);
• January EOM Put options with a 16500-strike priced at 127.70 points. Premium for 1 put is $2,551.40 (= 127.75 x 20).
In a rising market, out-of-the-money put options could be a strategy for small odds with big payoff. In January, we will have new data releases for December inflation (CPI and PCE) and nonfarm payroll employment, as well as a Fed meeting on January 31st.
My reasoning: If we see inflation rebound, stronger employment, or a hawkish Fed, the stock market could turn south, resulting in a gain for the put.
Hypothetically, if the March S&P futures price drops 150 points by January month-end options expiration, the put would be 47.25 points in-the-money (= 4710 – 4,662.75) and earn $2,362.5 (= 47.25 x $50). Using the initial margin as cost base calculations, the theoretical return would be 75% (= 2362.5 / 1350 - 1).
If the March Nasdaq drops 800 points (17,003.75-800=16,203.75) at January options expiration, the put would be 296.25 points in-the-money (= 16,500 – 16,203.75) and earn $5,925 (= 296.25 x $20). The theoretical return would be 132% (= 5925 / 2551.4 - 1).
On the other hand, if stocks continue to rise, put options will lose money, but never go beyond the premium already paid.
Options Calculator is a free tool CME Group provided for options traders. It generates fair value prices and Greeks for any of CME Group’s options on futures contracts or price up a generic option with this universal calculator. Traders could customize their input parameters by strike, option type, underlying futures price, volatility, days to expiration (DTE), rate, and choose from 8 different pricing models including Black Scholes.
www.cmegroup.com/too...ions-calculator.html
Happy Trading.
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Group Real-time Market Data help identify trading set-ups and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com/cme/
Jim W. Huang, CFA
jimwenhuang@gmail.com
jimwenhuang@gmail.com
