the Risk of Futures Exchange and Traded Funds Positions Some equity portfolio managers use futures as a key component of their portfolio construction process. When cash comes into an account, some portfolio managers may choose to "equitize" this cash. That means they purchase futures in an amount that gives them the same exposure as the cash value. So, for example, if a portfolio received a $50 million cash inflow, a portfolio manager may go long S&P 500 futures to the amount of a $50 million exposure. Since futures can play such an important role in portfolio construction, it's critical to understand how to measure the risk of futures positions within the context of an equity factor model. Before understanding the way that futures positions affect portfolio risk, we first need to analyze how a futures position impacts a portfolio's value. The market value of a futures contract is its initial margin plus any variation margin. Variation margin results from the mark-to-market (MTM) feature of futures contracts. For example, variation margin increases as the futures contract moves out-of-the-money. We consider an example using a futures contract on the S&P 500 index. Currently, each S&P 500 futures contract is worth 250 times the current market value of the spot S&P 500 index. So, if the value for the index is $1,500, then the market exposure of the S&P 500 futures contract is $375,000. Assuming a margin requirement of 5 percent, a portfolio manager would have to put down about $18,750. Naturally, if a portfolio manager purchases N futures contracts, then the market value would be N times $375,000 and the initial margin would be N times $18,750. At the end of each trading day, the mark-to-market of the futures contract is based on the formula MTM = 250 X fClose-of-business price of futures contract -Beginning-of-day price of futures contract). So, if the futures price at the beginning of the day is $1,500 and it closes at $1,450, then the MTM would be a loss of $12,500. MTM = 250 x ($1,450 - $1,500) = -$12,500 As futures are settled each day, the variation margin in this case is $12,500 and this amount would be added to the initial margin amount. A future's position weight in a portfolio is defined as its total market exposure ($375,000) divided by the portfolio's total invested capital. For example, suppose that a portfolio consists of two stock positions and one futures position. The futures position has a total market exposure of $375,000 and the stock positions are currently valued at $100,000 and $200,000. In this case, the total capital invested is $318,750 and the portfolio weights are: 31.4 percent ($100,000/$318,750), 62.7 percent ($200,000/$318,750), 117.6 percent ($375,000/$318,750), and 5.9 per-