As MCR’s Forte, and soon-to-be-released Adagio, strategies continue to gain momentum, we will inevitably face challenges related to scalability. There are several reasons the big players (e.g. hedge funds) typically trade futures contracts rather than exchange traded funds (ETFs) for index-centric strategies. Here are some reasons why:
Tax advantage – Futures traders currently benefit from a more favorable tax treatment than equity traders under Section 1256 of the Internal Revenue Code (IRC) which states that futures contracts are taxed at a 60/40 split of long-term capital gains and short-term capital gains rates respectively—regardless of how long the position is held. As long as financial industry lobbyists continue to dominate Washington to a hugely disproportionate degree, this will likely remain in place.
Relative volume consistency – Index futures trading volumes are generally more consistent month-to-month than ETFs (large professional speculators and “hedgers” are the biggest players in futures markets). YTD 2020, the NQ futures contract (NASDAQ-100) average monthly volume variance was only 6% whereas the more panic-susceptible QQQ and TQQQ ETFs clocked in at variances north of 20% (March saw monthly volumes soar 223% on average; arbitrage traders likely exploited this). More consistent volumes typically translate into more predictable order fills and less slippage.
Scalability – Index futures volumes are not only more consistent, they’re massive compared to ETFs. The Chicago Mercantile Exchange’s (CME) E-Mini S&P 500 (ES) futures contract is one of the most heavily traded investment vehicles in the world (when factoring in leverage). An investor trying to enter a $1M position for QQQ or TQQQ would represent as much as 3-5% of the first minute of opening trading activity whereas that same relative position could be entered with a mere 4 NQ contracts. And what would those 4 contracts represent within the first minute of trading? The trade size would equal 0.15% of the opening minute’s volume. That’s the big leagues for you.
Direct correlation – The NQ futures contract is a direct derivative of the NASDAQ-100 Index whereas ETFs QQQ and TQQQ price values, while mostly correlated, do not directly equate to the underlying. Although maybe less of a concern with higher volume ETFs, there will always be systemic risks (e.g. decay) when investing in long/short index ETFs (especially the leveraged ones).
24/7 (almost) – Most index futures contracts (e.g. ES, NQ, RTY, YM) open at 6pm EST on Sunday and close at 5pm EST on Friday (except for holidays). Can’t sleep and want to go long the NASDAQ-100 at 2am on a Wednesday? You certainly can…and the futures market will be liquid enough for most investors. Although stocks and ETFs have pre- and post- market trading hours, they remain limited and bid/ask spreads are generally unfavorable.
We continue to research and model performance enhancement ideas including those related to futures. Stay tuned.
Forte Strategy Update
No trades were executed last week as the volatility remained high blocking out new trades with the long equity ETFs while the upward market price moves precluded any VIX trades. The SP500 gained 2.2% last week and is up 11.0% for the year compared to a gain of 5.3% by our Forte strategy. While we have proven Forte’s ability to avoid and potentially profit during a declining market, we are doing extensive research to develop a new strategy (Adagio) that will trade with less frequency and be more effective in both avoiding a percentage of a major decline and capture more of the rebounding upside. And as stated in prior blog emails, we are working on a portfolio approach to blend the strategies together (including a classic buy-n-hold approach) for optimal performance.
More details about our trading activity can be found by registering on the Collective2 website and searching for Forte Strategy. A running list of these email blogs and general information about Maestro Capital Research can be found at maestrocapitalresearch.com.