Incremental futures contract: Meaning, Criticisms & Real-World Uses

What Is Incremental Futures Contract?

An Incremental Futures Contract refers conceptually to a type of futures contract designed to allow for smaller, more granular trading positions within the broader derivatives market. While "Incremental Futures Contract" is not a formally standardized industry term, it broadly describes contracts, such as the widely traded Micro Futures Contract (Micro E-mini), that break down traditional futures into smaller, more accessible units. This approach aligns with the field of financial derivatives, offering participants increased flexibility in managing exposure to an underlying asset without committing to the larger contract size of standard or E-mini futures²⁵, ²⁶. Such contracts are particularly beneficial for individual traders or those with smaller capital bases seeking to engage in speculation or hedging strategies.

History and Origin

The concept of futures trading dates back centuries, with early forms of forward agreements found in ancient Mesopotamia and Greece. One of the earliest organized futures exchange markets, the Dojima Rice Exchange in Osaka, Japan, emerged in the late 17th century. This exchange allowed merchants to trade "rice tickets" for existing stock or future production, effectively enabling the trading of rights to future delivery and laying groundwork for modern futures²³, ²⁴.

The modern evolution of futures contracts, including the development of smaller, more incremental offerings, has been driven by increasing market accessibility and technological advancements. While the Chicago Board of Trade (CBOT) listed the first standardized exchange-traded futures contracts in 1864, the introduction of financial futures in 1972 by the Chicago Mercantile Exchange (CME) marked a significant shift. Decades later, to cater to a wider audience, including retail traders who might find traditional contracts prohibitive due to their large notional value and associated margin requirements, exchanges began introducing "micro" versions of their popular futures products. For instance, the CME Group launched its Micro E-mini futures contracts in 2019, specifically designed to be one-tenth the size of their E-mini counterparts, thereby democratizing access to major equity indexes and other asset classes²¹, ²². These smaller contracts embody the principle of an Incremental Futures Contract by allowing traders to take more precise, smaller-step positions.

Key Takeaways

Incremental Futures Contracts are conceptually smaller, more accessible versions of traditional futures contracts, exemplified by Micro Futures Contracts.
They allow traders to participate in the futures market with significantly less capital compared to standard or E-mini contracts.
These contracts enable more precise position sizing and granular risk management.
They offer increased liquidity for smaller trading sizes while still providing exposure to major underlying assets.
Despite their smaller size, Incremental Futures Contracts still involve leverage and the inherent risks of futures trading.

Formula and Calculation

An Incremental Futures Contract, such as a Micro Futures Contract, does not have a unique calculation formula distinct from standard futures contracts. Instead, its value and profit/loss are derived directly from the movement of the underlying asset, similar to larger futures, but scaled down by a fixed multiplier.

The value change for an Incremental Futures Contract can be calculated as:

$\text{Profit/Loss} = (\text{Current Futures Price} - \text{Entry Futures Price}) \times \text{Contract Multiplier} \times \text{Number of Contracts}$

Where:

Current Futures Price: The prevailing price of the futures contract.
Entry Futures Price: The price at which the futures contract was bought or sold.
Contract Multiplier: A fixed value set by the futures exchange that determines the dollar value per point or tick movement of the underlying asset. For instance, the Micro E-mini S&P 500 futures contract has a multiplier of $5 per index point, which is one-tenth of the standard E-mini S&P 500's $50 multiplier¹⁹, ²⁰.
Number of Contracts: The quantity of Incremental Futures Contracts traded.

This multiplier is key to understanding the scaled-down nature of these contracts.

Interpreting the Incremental Futures Contract

Interpreting an Incremental Futures Contract involves understanding its proportional relationship to its larger, standard counterpart. Since these contracts are typically a fraction of the size of traditional futures, they allow for finer adjustments to market exposure. For example, if a standard futures contract represents a large block of an underlying asset, an Incremental Futures Contract allows a trader to take a position equivalent to one-tenth of that block. This granularity enables traders to scale into or out of positions with greater precision, aligning their exposure more closely with their desired risk management parameters¹⁸.

The interpretation of price movements remains consistent with larger futures: a rise in the contract's price indicates a gain for a long position and a loss for a short position, and vice-versa. However, the dollar impact of each "tick" (the smallest price movement) is proportionally smaller, which directly relates to the lower margin requirements and reduced capital outlay¹⁷. This makes them an attractive vehicle for market participants who wish to gain exposure without the substantial capital commitment traditionally associated with the futures market.

Hypothetical Example

Consider a hypothetical scenario involving an Incremental Futures Contract based on the S&P 500 index, specifically a Micro E-mini S&P 500 futures contract (MES). This contract has a multiplier of $5 per index point.

Suppose a trader believes the S&P 500 index will rise and decides to buy one MES contract.

Initial Action: The trader buys one MES contract when the S&P 500 futures are trading at 5,000 points.
Market Movement: The S&P 500 index moves up to 5,010 points.
Closing Action: The trader decides to sell their MES contract at 5,010 points.

Calculation:

Price difference = 5,010 points - 5,000 points = 10 points
Profit/Loss = 10 points * $5/point * 1 contract = $50

In this example, the trader realized a $50 profit. If they had traded a standard E-mini S&P 500 futures contract (ES), which has a multiplier of $50 per index point, the same 10-point move would have resulted in a $500 profit or loss, requiring significantly more initial capital and exposing the trader to a larger dollar risk per point of movement. The Incremental Futures Contract allowed the trader to participate in the market with a smaller financial commitment and proportionally smaller gains or losses, providing a more accessible entry point to the underlying asset's price movements.

Practical Applications

Incremental Futures Contracts, primarily in the form of micro futures, have several practical applications across various aspects of investing and market analysis:

Retail Trader Access: They significantly lower the barrier to entry for individual investors who may not have the substantial capital required for full-sized futures contracts. This allows participation in major markets like equity indices, commodities, and currencies with smaller margin requirements ¹⁴, ¹⁵, ¹⁶.
Precise Position Sizing: Traders can achieve more granular control over their market exposure. Instead of being limited to large jumps in position size, they can adjust their exposure incrementally, better aligning with their specific risk management strategies and account size¹³.
Portfolio Diversification: For investors with smaller portfolios, Incremental Futures Contracts offer a cost-effective way to gain exposure to different asset classes for diversification purposes without overcommitting capital to any single position¹².
Strategy Testing: New traders or those developing new strategies can utilize these smaller contracts to test their approaches with real money and real market conditions, but with reduced financial risk, before scaling up to larger contract sizes¹⁰, ¹¹.
Hedging Smaller Portfolios: Businesses or individuals with smaller-scale exposures to commodity prices (e.g., small agricultural producers, energy consumers) can use Incremental Futures Contracts to hedge against adverse price movements in the spot price more precisely.
Capital Efficiency: While still involving leverage, the lower notional value means less capital is tied up per contract, freeing up funds for other investment opportunities. Major exchanges like the CME Group offer resources explaining the benefits of these contracts CME Group Micro E-mini Futures.

Limitations and Criticisms

While Incremental Futures Contracts offer significant advantages, particularly for accessibility and granular control, they are not without limitations and criticisms.

One primary concern, inherited from all futures trading, is the inherent leverage. Even with smaller contract sizes, the ability to control a large notional value with a relatively small amount of capital can magnify both profits and losses. A small adverse price movement can result in a significant percentage loss of the initial margin deposit, potentially exceeding the original investment⁷, ⁸, ⁹. This means that while the dollar amount at risk per tick is smaller, the percentage risk relative to invested capital can still be very high.

Another criticism revolves around the potential for overtrading or excessive speculation. The lower margin requirements of Incremental Futures Contracts might encourage inexperienced traders to take on more positions than they can adequately manage, leading to increased risk exposure and potentially significant losses during periods of high market volatility ⁶. The ease of entry does not diminish the complexity or the inherent risks of the futures market.

Furthermore, while these contracts are designed to increase liquidity for smaller participants, extreme market conditions can still lead to challenges in execution or wider bid-ask spreads, impacting profitability. The National Futures Association (NFA) and the Commodity Futures Trading Commission (CFTC) regulate the U.S. derivatives industry to ensure market integrity and protect investors. However, they consistently caution about the significant risks involved in futures trading, emphasizing that losses can exceed initial investments³, ⁴, ⁵. Investors should thoroughly understand these risks before engaging, as highlighted in publications from regulatory bodies like FINRA FINRA Security Futures Risks.

Incremental Futures Contract vs. Micro Futures Contract

The term "Incremental Futures Contract" is a conceptual descriptor that broadly refers to futures contracts designed to offer smaller, more granular trading increments. It is not a formal, recognized financial product name. In contrast, a Micro Futures Contract is a specific, standardized type of futures contract traded on regulated exchanges.

The distinction lies in their nature: "Incremental Futures Contract" describes the functionality or design philosophy of providing smaller trading sizes, whereas "Micro Futures Contract" is the actual product name that embodies this incremental design. For example, a Micro E-mini S&P 500 futures contract is a specific Incremental Futures Contract. Micro futures are officially listed by futures exchanges with defined contract sizes and multipliers that are typically one-tenth the size of their corresponding "E-mini" contracts¹, ². Therefore, while all Micro Futures Contracts are examples of Incremental Futures Contracts, the latter is a broader, less precise term.

FAQs

What makes a futures contract "incremental"?
A futures contract is considered "incremental" if it is designed to represent a smaller fraction of the value of a standard futures contract, allowing traders to take more granular positions. This typically means lower margin requirements and a smaller dollar value per tick movement of the underlying asset. Micro Futures Contracts are the most common examples of this design.

Are Incremental Futures Contracts less risky than standard futures?
While Incremental Futures Contracts involve a smaller notional value and thus a smaller dollar amount at risk per contract, they still utilize leverage. This means that a relatively small price change in the underlying asset can still result in significant percentage losses relative to the capital invested. The overall risk depends on factors such as position size, market volatility, and risk management strategies, not just the contract size itself.

Who typically uses Incremental Futures Contracts?
Incremental Futures Contracts are particularly popular among retail traders, new investors, or those with smaller capital bases who want to gain exposure to the futures market without the substantial capital commitment required for larger contracts. They are also used by experienced traders for precise position sizing and testing new strategies with reduced risk.

Where can I trade Incremental Futures Contracts?
Incremental Futures Contracts, specifically Micro Futures Contracts, are traded on major futures exchanges globally. In the United States, popular examples include the Micro E-mini contracts offered by the CME Group, covering major equity indexes, precious metals, and cryptocurrencies. Trading is facilitated through brokerage firms that offer access to these exchanges. All trades are cleared through a clearing house, which acts as a guarantor to both sides of the transaction.