A lot of times we as traders focus on the entry and exit price of a particular trade or investment but far too much is often understated in this equation. I was recently reviewing some of my trades and realizing the large difference that trading costs and taxes take on trading equities and futures. I think there is significant performance improvements to be had by attempting to reduce these two components. I typically pay about 0.003 per share in equities or $5 per trade. In futures I pay around $1.50 per contract. A question I am often left asking myself is: is there a threshold where trading shares makes sense and a point when trading futures makes more (economic) sense.
Typically 500 shares of SPY is the same as 1 S&P500 EMINI futures contract. So if SPY goes up $0.50 you stand to make about $245 (250 – commission). In order to make that same $250 in futures you need a 5 point move. This is pretty typical and common for the two to work out to be the same but obviously the futures commission is less at this point. In this trade we made $245 in SPY and $248.50 in the futures contract.
Now let’s double the size and repeat this experiment (same $0.50 gain and 5 points futures gain). In SPY we would have made $0.50 on 1000 shares which is $500 – $5 = $495 total. In futures we would have made 2 contracts worth of 5 points = $500 – (2 * 1.50) = $497. Anyways, you can repeat this experiment two more times until we have a position of 2000 shares of SPY and 4 futures contracts and at this point we actually begin to make more with SPY.
Or do we? The two other missing components to this equation are slippage. This means that buying 2000 shares of SPY should theoretically have more slippage than buying just 500 shares. Both markets have ample liquidity for 2000 shares and 4 contracts respectively so I will refrain from going more down the slippage rabbit hole.
Let us continue with the 3 version of the above experiment. That is when we have 1500 SPY shares and 3 futures contracts. These two positions on a $0.50 move or 5 point move leave us with $745 and $745.50 respectively but let’s call it an even $745 for both. If we were to repeat this trade 120 times per year (or every other day let’s say) and this was our entire trading strategy what would the year end results look like AFTER TAXES?
120 * 745 = 89,400 * .25 tax bracket
120 * 745 = 89,400 * 60/40 futures taxes
What are futures taxes? The first 60% are taxed at long term capital gains rates not ordinary income rates (the 25% above for SPY). This means we save over 10-20% on 60% of our money. How much does this work out to be? It works out to be a whopping $5,364+.
SPY taxes: $22,350 or 89400 * .25
Futures taxes: $16,986 or (89400 * .6 * .15) + (89400 * .4 * .25)
This is significant savings and almost a full extra contract of margin to play with in the upcoming year. This can help compound earnings and the account faster and not to mention is much simpler come tax time as futures require one line on the tax form vs. itemizing each individual stock trade. Not to mention 89400 divided by 12 months is roughly 7,450 in monthly income. 5300 extra money saved on taxes is 75% of one month’s pay. That means by trading futures instead of stocks you get an extra 3 to 4 weeks of earnings per year.
So when traders are discussing their actual returns I think it is very important to discuss the actual returns and not the pre tax returns because I would much rather make money trading futures than stocks the more I look at the math and grow my account. It makes sense why most of the full-time traders I have met are primarily focused on futures not to mention less restrictions on short selling and less margin required.