Diary of a Financier

Fivefold Increase in Equity Futures Open Interest: Displaces Cash Markets, Multiplies Leverage

In Idiosyncrasy on Thu 5 May 2011 at 23:17
  • The volume in futures markets has far more than displaced the waning volume in cash markets.
  • The linear growth of Open Interest in E-mini futures dangerously multiplies the leverage in the system.
  • Veiled excesses like this pose systemic risk, because they’re capable of taking everyone by surprise.

In light of my refuting interest rate derivatives as a systemic risk, I thought I’d record a real suspicion of mine that I’m investigating.  I’m curious about the modern volume in equity index futures (S&P 500 regular & E-minis), wherein there may be enough activity to displace the lost volume in cash markets like the NYSE.  The problem with such cash market volume waning relative to futures volume is the amount of leverage induced by the latter.  Not only do I find evidence for such timely handoff from cash to futures markets, but I also find that E-mini futures have undergone a linear growth in open interest that multiplies the investment participation in the market (not to mention the leverage).

Futures markets like those run by CME have low margin requirements: speculators only have to post margin of $5,625 against a single S&P 500 E-mini contract (ES/1), which is worth around $68k as of today.  That’s only an 8% initial margin requirement.  CME members need only post 6% initial margin to buy a contract, and the margin maintainance level for all contract holders is as low as 6%… that’s 16.7x leverage!  Unless you’re afraid of leverage (and we’ve repeatedly found that few fear leverage on the Street), why buy in the cash markets when you can post 6% margin in futures then stash the balance (94%) in a bond earning interest?  That balance represents opportunity cost.

Because of futures’ low margin requirements, that could substantially increase the leverage in the system unbeknownst to almost everyone—which is exacerbated by the fact that margin balances at Broker/Dealers (mostly a cash market concern) are already back at 2000 & 2007 highs.

To trace a discrepancy in the relative volumes in equity cash v. futures marketplaces, I used the SPY as my cash market control group.  The regular S&P 500 futures contract is SP/1, and at 1/5th its size, the E-mini futures contract is ES/1.  Compare the following price & volume charts:

SPY daily volume (yellow bars)

SP/1 futures daily volume (yellow) and Open Interest (blue)

ES/1 mini futures daily volume (yellow) and Open Interest (blue)

As seen above, the SPY cash market volume pyramids to a precipice in the height of the 2009 crisis, steeply declining thenceforth.  SP/1 futures show a similar decline in volume subsequent to the 2009 lows.  Here’s where it gets interesting: ES/1 E-mini futures have a volume spike in 2009 (yellow bars), but volume is steady otherwise.  Further, Open Interest (blue line) for the ES/1 slopes steadily higher, compared to a downward sloping SP/1 Open Interest.  Both the volume & Open Interest in ES/1 starkly contradict the cash market trend.  When multiplying out the notional value in each contract, I find these additional cashflows to E-mini futures account for almost 5x the lost Open Interest in regular futures since the market lows.  That’s not just displacing the lost volume in cash markets, but multiplying it–more participation, more leverage.

Need I expound on the implications?  I think Tommy Boy said it best, “I get all excited. I’m like Jojo the idiot circus boy with a pretty new pet.”  It’s the same old reel about excess and exuberance.  Unlike so many other “Black Swans” that’ve flocked across the news over the past two years, this is something veiled enough to actually take everyone (from retail investors to regulators) by surprise.

I’m actually wrapping up the second volume of Jack Schwager’s heralded Market Wizards interview series.  Of George Soros fame, Stanley Druckenmiller engaged in a dialogue for the book circa 1992, wherein he described a rare exchange he had with Jack Dreyfus before the crash of 1987:

Howard Stein brought a visitor to my office. “This is Jack Dreyfus,” he announced.

Dreyfus was wearing a cardigan sweater and was very polite in his conversation. “I would like to know about the S&P futures contract, he said. “As you know, I haven’t looked at the market for twenty years. However, I’ve been very concerned about the conversations I’ve been hearing lately when I play bridge. Everyone seems to be bragging about all the money he’s making in the market. It reminds me of everything I read about the 1929 market.”

Dreyfus was looking for evidence of margin buying to confirm his conjecture that the market was poised for a 1929-type crash. The statistics on stocks didn’t reveal any abnormally high level of margin buying. However, he had read that people were using S&P futures to take long positions in the stock market at 10 percent margin. His hypothesis was that the margin-type buying activity was going into futures. To check this theory, he had me do a study to see if there had been any unusually heavy speculative buying of S&P futures

…we finished the analysis on October 16, 1987. Basically, the data showed that speculators had been consistently short until July 1987 and after that point had switched to an increasing heavy long position…

…Dreyfus came by. He said, “Forgive me for not telling you before, but I had already sold S&P futures to hedge my exposure in the stock market.”

…”When did you go short?” I asked.

“Oh, about two months ago.” In other words, he had gone short exactly at the top. [And the market crashed the very next day, October 19, 1987.]

Thing is, it was tough aggregating S&P futures data in 1987.  Today, S&P futures data is readily available and widely accessed.  As I mentioned as recently as my interest rate derivatives rant, a Black Swan isn’t that remote if it’s in plain sight and everyone’s watching it.  However, while S&P futures (SP/1) are a widely recognized contract, the S&P E-mini futures (ES/1) are a fresh innovation from our friends in the derivatives business.  This one  could… go… all… the… way!  Keep watching.


  1. Wow! How do you uncover this stuff??? And where do you create the time each day to not only conceptualize, but scribe and do the research…you’re a machine. This is disconcerting. The folks at the fed and SEC should be all over this, but alas, they snooze once again! Reminds me of the time in 2003 when I queried different groups of so-called experts re: the volume of highly leveraged ARMs issued at initially discounted interest rates…everyone of them said it would never be a problem. I should have researched, written and published a prophecy!! You should do the same.

  2. […] ain’t good.  Neither is the chart of S&P E-mini Futures (ES/1), which holds the key, so I’ve said: ES/1 […]

  3. […] I wanted to update my S&P 500 E-mini Futures (ES/1) charts to illustrate the continuation of the bear trend that worried me back on May 16: SPY will open below critical support this morning.  That ain’t good.  Neither is the chart of S&P E-mini Futures (ES/1), which holds the key, so I’ve said. […]

  4. Hi — thank you for your post.

    SP1 = Pit trade S&P futures and predecessor to the e-mini S&P (ES). Volumes have been shrinking since the introduction of electronic trading on CME post 2000. The pit traded contract is essentially kept on for show & nostalgia (not to mention there is a service that provides the “noise” from the pit, indicating trader sentiment).

    ES1. Yes, I find it odd that open interest has been increasing into this recent decline, usually liquidation/washout is more characteristic of reduction. Plse also bare in mind you can see 2 or 3 day spikes up/down in open interest during the calendar roll (e.g. when traders liquidate the Sep. contract and move into Dec.).



  5. […] stop watching futures markets, but now that a full quarter has passed since my May entry, “Fivefold Increase in Equity Futures Open Interest: Displaces Cash Markets, Multiplies Leverage,” I’ve had the opportunity to step back and view equity futures’ progression from […]

  6. […] of both High-Frequency Trading (HFT) and S&P 500 E-mini Futures (ES/).  In May 2011, I fully discussed my concerns about ES’s displacement of cash markets like the actual S&P 500 Index (SPX) […]


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