How futures work
A futures contract is a standardized agreement to buy or sell a specific quantity of an underlying asset at a predetermined price on a specified future date. Futures trade on exchanges (CME, CBOT, ICE) and are marked to market daily — gains and losses settle every day, not at expiration.
For equity index traders, the E-mini S&P 500 (ES) and Micro E-mini (MES) are the primary instruments. ES represents $50 times the S&P 500 index level; MES is $5 times. A 1-point move in ES is worth $50; a 1-point move in MES is $5. These are the most liquid futures in the world and trade nearly 24 hours a day.
Futures converge to the cash index at expiration through a process called cash settlement. Before expiration, futures trade at a premium or discount to cash (the "basis") based on the risk-free rate and dividends. When rates are high, futures typically trade at a premium to cash.
Futures contracts expire quarterly (March, June, September, December for ES). As expiration approaches, traders "roll" from the front month to the next — closing the near-term contract and opening the later-dated one. Understanding roll periods is important; volume and pricing behavior changes around rolls.
Open interest
Open interest (OI) is the total number of outstanding contracts that have not been settled. Each contract represents one buyer and one seller — OI increases when new positions are opened and decreases when existing positions are closed.
Rising price with rising OI confirms a trend — new money is entering the market in the direction of the move. Rising price with falling OI suggests short-covering rather than genuine new long interest — the move may be weaker. Falling price with rising OI confirms a downtrend. Falling price with falling OI suggests long liquidation in a potentially exhausted trend.
Large OI clusters at specific price levels can act as support or resistance. These represent positions that participants are defending. If price approaches a large OI cluster, watch order flow carefully for absorption or rejection.
COT as a sentiment tool
The Commitment of Traders (COT) report, published every Friday for the prior Tuesday, breaks down futures positioning by participant type. Commercial hedgers (large institutions using futures to hedge real exposure), large speculators (hedge funds, CTAs), and small speculators (retail) each have different positioning patterns.
Extreme positioning by large speculators is often contrarian. When large speculators are at historically extreme net-long positions in S&P futures, the risk of a reversal is elevated because they represent potential forced selling if the market turns against them.
Commercial hedgers are the "smart money" in commodity futures — they have the best information about supply and demand. In equity index futures, their positioning is less cleanly interpretable, but net-long commercial positions at historical extremes have historically preceded rallies.