What are Small Cap Futures?
Small cap companies are those with a market valuation between $300 million and $2 billion. Historically, they’re considered risky investments, since growing companies tend to face more strife than well-established ones. Many investors leverage this risk into a huge return on investment (ROI)—especially when it comes to capitalizing on small cap futures.
Small cap futures are a forward-looking bet on the performance of small cap companies, usually gauged through index performance. Taking out a small cap futures contract means speculating about the performance of the market in the future—buying if you believe it’ll outperform; selling if you believe it’ll underperform.
Here’s a closer look at small cap futures and their application as an investment vehicle. While not for the faint of heart, they’re a powerful driver of wealth when your bet pays off.
What are Futures?
Futures, like options, are a form of derivative that looks ahead to speculate on the price of a s security. The difference is that, for options, investors can determine whether they want to transact based on the current price. They have the option. For futures, the contract-holder is required to exercise the contract when it comes due.
Because future contracts lock in a future sale at a specific cost, they’re typically used as a hedge against risk. For example, futures are popular among commodity investments. A soybean seller might lock in a price before harvest, as a hedge against poor crop yields. Meanwhile, a buyer might see that same price as a value in the face of higher future demand. Regardless of who’s right or the price of soybeans at the time of the contract, the transaction happens at the predetermined price.
Commodities aren’t the only application for futures contracts. Small cap futures are also of particular interest among investors with a healthy risk tolerance.
How to Invest in Small Cap Futures
To capitalize on the potential of small cap futures, investors need to secure a futures contract for a small stock or cap index. For most, the simplest solution is through E-mini Russell 2000 Index Futures (RTY). There are also futures available through the Russell 2000 Growth and Russell 2000 Value indexes.
Russell indices are the pinnacle for small cap stocks in the United States. Investors tracking these indices can leverage futures to predict price momentum into the future—usually quarterly. According to CME Group—the organization that orchestrates E-mini Russell 2000 Index Futures—”a single RTY contract has a value of $50 times the agreed upon E-mini Russell 2000 futures price, and trades in increments of 0.10 index points, with 1 tick equaling five dollars.”
Single Stock Futures (SSF) are also an option in international markets. Unfortunately, as of 2020, the only United States institution to offer SSFs, the OneChicago exchange, no longer operates. Abroad, however, SSFs are more common—especially in South Africa, where 700,000 single-stock futures change hands daily.
What Small Cap Futures Tell Investors
While investing in small cap futures is one way to capitalize on future market performance, it’s not the only way. Those who don’t have the appetite for futures can look at the current state of future contracts to gauge forward-looking investor sentiment about market performance.
- Higher future contract values indicate that investors believe small caps will deliver large returns in the future. Investors willing to lock in higher prices are bullish.
- Lower future contract values signal investors believe a pullback is coming—one that will affect small caps particularly. This is a bearish sentiment.
Without opening a futures contract, investors can use current sentiment to act accordingly in specific positions. It’s also important to pay attention to volume, as context for market momentum and the weight of future contracts.
The Risk and Reward of Small Cap Futures
Small caps are risky in and of themselves, often facing price volatility. At the same time, futures contracts offer their own form of risk—you’re obligated to satisfy the future terms of the contract. Together, these two variables set the stage for significant risk or reward.
If a small cap futures contract turns out to be correct, the potential for ROI is significant. Futures contracts are leveraged, meaning a contract that’s priced lower than market value has the potential to deliver exponential returns. However, the same is true in the opposite scenario. Overzealous or incorrect predictions about future price can lock investors into a price point that incurs significant losses.
The best way to mitigate the risk of a futures contract is to parlay it with an options contract. Since the most an investor can lose on an option is the premium paid to secure it, investors can shield themselves from massive losses on small cap futures by taking out an option for the same expiry period.
Looking Ahead at Small Cap Performance
Futures contracts—like any derivative—are a speculative investment. You’re predicting the future performance of small cap stocks. As a result, risk and reward are relative. Investors stand to capitalize on the often strong appreciation of small cap stocks and indices. However, if they’re wrong or small caps don’t perform to the level an investor believes they will, they risk incurring significant losses.
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Whether you invest directly in small cap futures or use them as a barometer for other forms of speculation, make sure you’re practicing hedging strategies. Have a clear understanding of futures and options, and use them in tandem to create high upside with mitigated worst-case scenarios in the background.