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What Are Single Stock Futures?
Single stock futures are futures contracts
on individual stocks. There are currently over 80 well-known stock
futures such as IBM, eBay, and Philip Morris. These futures products
provide investors with a cost-effective vehicle for participating in U.S.
equities markets.
A stock futures contract is an agreement to deliver shares of a specific
stock at a designated date in the future, called the expiration date.
Most stock futures contracts are not held until expiration because traders
typically offset their position - selling if the trader is long or buying
if the trader is short.
The price of an equity futures typically tracks the price of the
underlying instrument nearly tick for tick, so trading strategies followed
in the stock market are generally transferable to the stock futures
market. Single stock futures may therefore be used with a broad
range of trading strategies and for a variety of portfolio management
needs.
When a stock future is traded, both the buyer and seller put up a good
faith deposit called margin. The margin requirement for security
futures is generally 20% of the underlying value of the securities,
although this requirement may be lower if the investor also holds certain
offsetting positions in cash equities, stock options, or other security
futures in the same securities account.
Advantages of Single Stock Futures
Selling A Stock Short
One plus is the ease and diminished expense of taking a short position in
a single stock. Selling a stock short in the stock market is relatively
complicated and expensive. A short sale in a stock necessitates locating
the shares to borrow and paying the broker loan rate of interest. You must
then wait for an uptick to sell the stock short. Waiting for an uptick to
sell a stock short in a declining market can be frustrating and costly. By
the time a particular stock upticks, it could be substantially below the
price at which you wanted it sold. However, in the futures market with the
SSF contract, you can sell a stock short just as easily as you can buy
one. When you sell a stock short using an SSF contract, you don’t have
to wait for an uptick. You can sell when you want, without going to the
trouble of finding the stock and without the expense of paying the broker
loan rate of interest on the shares borrowed.
Risk Management
Selling SSF contracts can also greatly contribute to risk management in an
investor’s portfolio with possible tax benefits. Instead of selling
specific stocks in one’s portfolio during market downturns, an investor
could sell an equal amount of shares in SSF as a hedge against his or her
stock position. The ability to hedge a particular stock facilitates
holding onto the underlying position in the stock market for longer
periods of time, thereby potentially providing investors substantial tax
savings in long-term versus short-term gains.
Speculation
An investor without owning any stock could use SSF to speculate outright
on an anticipated increase or decrease in the price of a stock.
Margins
One major difference between stocks and futures centers on the role of
margins. For stocks, margins, which are set by the Federal Reserve's
Regulation T, have been at 50% for retail investors and 15% for dealers
since 1974. A stock investor buying on margin borrows the difference, and
can either pay the loan down, or offset it when the security is sold.
Futures margins, which are set by the exchange, don't represent a down
payment on an asset -- but are rather a performance bond from the investor
to the exchange clearinghouse. Margins vary quite widely as a percentage
of the underlying asset, but generally are quite low. For example, the
underlying value of the S&P 500 future is hovering around $335,000,
but the initial margin for a speculator is only $23,438, or less than 7%.
The futures investor doesn't have to pay interest on the remaining
93%;indeed, futures investors can deposit T-bills and earn interest on 90%
of the deposit with a 10% haircut in their margin accounts.
Cost Advantage
SSF are traded in 100-share blocks, virtually mirroring the price movement
in the single stock on which the futures contract is based. A $1 move in
an individual stock equals $100 in an SSF contract. There is a big cost
advantage here. In order to control shares in a stock, you need to post at
least 50% margin and pay interest on the balance. In SSF, all that is
required is approximately 20%, or less than half the margin required in
the stock market. Additionally, there is no interest charge on buying or
selling a stock on margin in SSF. Essentially, you will earn or lose the
same in an SSF contract as you would when buying 100 shares of stock.
Commission Savings
In all probability, the transaction costs in buying or selling a SSF
contract amounts to less than buying or selling the same 100 shares of
stock in the stock market.
Spread Differentials
SSF offers investors additional investment strategies. For example, if an
investor feels the price of one stock will decline or rise in relation to
another stock he or she can buy a SSF contract on one stock and sell a SSF
contract on another, hoping to profit from the spread differential between
the two stocks anytime up to the contact’s expiration.
No Clearing Fees on Foreign Markets
Investor can also gain cross border exposure without the expense of going
through foreign clearing systems. Will circumvent many of the difficulties
faced by investors attempting to trade across jurisdictional boundaries by
providing access to UK, European and US shares on a single trading
platform.
Universal Stock futures transactions will be clear of costs of accessing
settlement systems across international borders
Greater Versatility
SSF allows a trader to potentially profit no matter what direction the
market moves. If a trader is of the opinion that the stock market is going
to fall, a trader can sell a contract. A profit will be made if the trader
then buys that contract back later when the price decreases. This avoids
the hassle of stock borrowing.
Electronic Trading Platforms
SSF will are traded on electronic trading platforms available to the
public through the internet. Investors will have universal access to the
same sources of information, delivery, and speed of execution that only a
few years ago were available primarily to professionals. Price fills are
routinely provided in seconds.
Frequently Asked Questions
Are Single Stock Futures better than trading stocks?
An advantage that single-stock futures have over trading stocks is that
you can sell without waiting for an uptick. So, when the stock price is
dropping, you might be able to take a short position in single-stock
futures sooner than if you wait for an uptick to sell the stock itself.
Are Single Stock Futures better than
trading equity options?
Single-stock futures are more straightforward than equity options, where
you have to decide which strike price to trade within each contract month,
a decision that may involve an analysis of time premium. With futures,
it's an easy decision: Do you believe the price of the underlying stock is
going to higher or lower than the current price indicated by a certain
futures contract when that contract expires? Buy futures if you think the
price will be higher. Sell futures if you think the price will be lower.
It’s that simple!
How big are Single Stock Futures
contracts?
Each futures contract represents 100 shares of underlying stock. That is
the contract size used at LIFFE and by the Chicago Board Options Exchange
(CBOE) for equity options.
What are the margin requirements for
Single Stock Futures?
The initial margin requirements for Single Stock Futures will be 20% of
the contract value. If so, margin would be $2,000 for one contract that
represents 100 shares of a $100 stock (contract value of $10,000).
How is a Single Stock Futures
contract different from an equity option
contract?
When you buy or sell a single-stock futures contract, you are obligated to
fulfill the terms of the contract upon its expiration (unless
you offset the position before then). When you buy an equity option
contract, you have the right, but not the obligation, to either buy or
sell
100 shares of the underlying stock at the option's strike price by the
time the contract expires. When you sell an equity option contract, you
are
obligated to either buy or sell 100 shares of the underlying stock at the
option's strike price at contract expiration.
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