Trading conditions have sharply deteriorated in a popular vehicle for betting on swings in the S&P 500, exacerbating the volatility in the stock market in the past two weeks.
E-mini S&P 500 futures play a huge, if little understood, role in financial markets, with hundreds of billions of dollars of trading activity each day. They track the S&P 500 and typically move in lockstep with the broad-based index.
For reasons that aren’t fully clear, liquidity in the E-mini market has been unusually depressed during the past two years. It eroded to near record lows during the coronavirus-fueled selloff of late February, and it is still thin—a sign of potential turbulence going forward.
For most of 2017, the average number of E-mini contracts available to be bought or sold within a tight band around their current price, corresponding to a one-point move in the S&P 500, hovered between 3,000 and 6,000, Deutsche Bank data show.
But over the past two years, that number has rarely climbed above 2,000 contracts. On Friday, it fell to just 163 contracts—down more than 80% from a week earlier—before slipping even further, to 132 contracts, on Tuesday, according to Deutsche Bank.
The term “liquidity” refers to the ability to execute a big trade without affecting the price of an asset. In layman’s terms, lower liquidity means that when a wave of selling hits a particular market, prices drop more sharply than they would have otherwise. In the case of the E-mini, heavy selling has a knock-on effect on the stock market itself—and on investors’ portfolios.
There are various ways to measure liquidity, and it is a matter of debate which is best. A simple approach is to look at the trading volume of a particular market. By that standard, liquidity in E-minis has never been better, hitting a record on Friday with more than $850 billion traded that day.
But the liquidity metric tracked by Deutsche Bank’s analysts—the number of contracts available to be bought or sold—offers a measure of how fragile a market is. When there are lots of traders posting quotes to buy E-mini contracts, they effectively act as a buffer against sellers putting downward pressure on the S&P 500.
And by that standard, the buffer is now very thin.