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(Day) Trading Futures vs. ETFs, Stocks

Trading futures spreads, there are important reasons why spread trading should be considered if you’re looking for an approach to trading futures.

by John D. Thorpe, Senior Broker

According to the Wall Street Journal, assets in Exchange Traded Funds (ETFs) have grown to roughly $2 trillion dollars since their inception. Exchange-Traded Funds were created to compete with the $20 trillion dollar Mutual Fund Market as it was the only market in which you could achieve broad class diversity outside of individual stocks. ETFs were also designed to overcome the drawback that mutual funds could only settle on the close of daily business at their Net Asset Value (NAV). Previously, broad diversification across market sectors could only be purchased or sold at the close of the business day based on the equity, bond or raw material elements included in the weighted averages of every component of the sector mutual fund—thus, ETFs came into play.

The first Exchange Traded Fund, the Spider or SPDR, was the S&P 500 depository receipt which was designed to track the S&P 500 stock market Index and began trading in January of 1993. No longer could an investor achieve broad market exposure on just the close of the business day, but could now buy and sell the broad market at any time throughout the trading day. Market makers and specialists provided liquidity for ETFs and continue to do so today.

During the May 2010 so-called “Flash Crash”, the NYSE canceled all trades that were more than 60% away from pre-crash prices; leaving some with dangerous consequences. This was arbitrary and arguably covered up liquidity issues at the largest stock exchange in the world. E-Mini S&P 500, E-Mini Dow 30, E-mini Nasdaq 100 or Mini Russell 2000 Futures were not canceled as a result of this market event. None of the above futures contracts were even down 10%. The Dow was down 5.7% at its worst.

Fast Forward to August 24th, 2015. Another rocky moment in the market’s history as several ETFs were down double-digit percentages and not even trading. Yet, in comparison, the weighted stocks that made up the ETFs value were only down a few percentage points. According to FactSet, the IShares Dividend ETF NASDAQ, DVY was down 35% while the combined values of the stocks held in that ETF were only down 2.7 %. One of the possible reasons for this disparity? Perhaps, market makers backed away and pulled their bids creating an enormously wide bid and offer spread which is symptomatic of an illiquid market. A wider bid and offer spread creates a situation where the small investor pays more than the issue is worth by paying an inflated price at the ask and receives less in return for selling at a bid price that is less than the issue is worth.

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* Please note that the information contained in this letter is intended for clients, prospective clients, and audiences who have a basic understanding, familiarity, and interest in the futures markets.

** The material contained in this letter is of opinion only and does not guarantee any profits. These are risky markets and only risk capital should be used. Past performances are not necessarily indicative of future results.

*** This is not a solicitation of any order to buy or sell, but a current market view provided by Cannon Trading Inc. Any statement of facts herein contained are derived from sources believed to be reliable, but are not guaranteed as to the accuracy, nor they purport to be complete. No responsibility is assumed with respect to any such statement or with respect to any expression of opinion herein contained. Readers are urged to exercise their own judgment in trading!

Seasonal tendencies are a composite of some of the more consistent commodities futures seasonals that have occurred over the past 15 years. There are usually underlying fundamental circumstances that occur annually that tend to cause the futures markets to react in a similar directional manner during a certain calendar period of the year. Even if a seasonal tendency occurs in the future, it may not result in a profitable transaction as fees and the timing of the entry and liquidation may impact on the results. No representation is being made that any account has in the past or will in the future achieve profits utilizing these strategies. No representation is being made that that price patterns will recur in the future. Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk in actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all of which can adversely affect actual trading results. Results not adjusted for commission and slippage.

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