FREQUENTLY ASKED QUESTIONS
Single-Stock Futures
by Jayanthi Gopalakrishnan
Why has it taken so long to launch single-stock futures (SSFS) in the US?
How can you take advantage of them? To find out, we asked OneChicago and Nasdaq LIFFE, the two exchanges expected to launch this hot new product, a few questions. Here's what they had to say.OneChicago: The products were banned about 20 years ago when the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) could not agree on who had jurisdiction over them. The Commodity Futures Modernization Act of 2000 said the two must jointly regulate single-stock futures. It has taken almost two years for the SEC and CFTC to come up with the trading rules, regulations, and so on that are required in the act.
Nasdaq LIFFE: With all the optimism and desire surrounding SSFs, many have not fully appreciated how complicated it is to create something under two regulatory regimes. The SEC and the CFTC had an enormous amount of work in front of them to put together a product that worked under both umbrellas. If you look at the other things that were going on simultaneously, in retrospect, it is easy to understand why it took a while to get here. The bottom line is that launch is imminent.
It seems that options are an existing vehicle for speculating on future stock prices. Why do we need SSFs?OneChicago: Single-stock futures are simpler and cheaper, but they also carry more risk. An option contract requires the trader to pick a strike price. Stock futures only require traders to pick the direction they think the stock will go (up or down). When buying options, the most a trader can lose is the amount paid for the put/call, called a premium (selling has much more risk). When buying or selling futures, the risk is much greater.
Nasdaq LIFFE: Options and futures both are vehicles that can be used in a speculative fashion. Regardless of the intent of an investor in selecting an investing vehicle, it is important to acknowledge that futures and options have different characteristics. While you can replicate the look, feel, and economic behavior of a futures contract by trading a short call with a long put or a long put with a short call, options and futures are still different products. If you are replicating futures using options, you have to execute two bid/asks rather than one.
Options have premiums attached to them because they do not represent an obligation. The premiums vary with the market movements. Traders who want to hedge a preexisting long position against downward movement can simply look at a futures contract, lock it in, and be done with it, or they can look at options and reproduce the behavior of the futures contract using different strategies. Options are priced depending on the perceived risk in the market at the time. They reflect the volatility in the stock. The bottom line is that options and futures are different.
What are the contract specifications?OneChicago: Each single-stock futures contract is equal to 100 shares of the underlying stock. All contracts will be physically settled, meaning that if the contract is held until expiration, the owner of the contract will receive 100 shares of stock if he/she is long, and owes 100 shares for each contract he/she is short.
Nasdaq LIFFE: The contract specs for NQLX can be found at: https://www.nqlx.com/Nqlx/Ssf/ContractSpec.stm.
How much leverage will be allowed per single-stock futures contract?OneChicago: In general, margin requirements are 20% of the cash value of the contract. However, that margin can be reduced further if the trader also holds certain offsetting positions in cash equities, stock options, or other securities futures in the same securities account.
Margins work like this: let's say company XYZ is trading at $50 a share. Each single-stock futures contract is equivalent to 100 shares of the underlying stock. In order to purchase an XYZ single-stock futures contract, a trader would have to put down $1,000: $50 (share price) * 100 (number of shares) = $5,000, and 20% of $5,000 is $1,000.
Nasdaq LIFFE: The general number is 20%. There are certain offsets that will allow that number to be lower.
If the market goes against your position, will you be required to have a performance bond to make up the difference?OneChicago: Yes, as is typical for futures contracts.
Nasdaq LIFFE: You are going to have to maintain initial and maintenance margin; otherwise, you can expect to be liquidated.
Will SSFs be fungible?OneChicago: No, not at the beginning.
Nasdaq LIFFE: No. We support fungibility, but can't implement it unilaterally.
How many SSFs are going to be offered when they are launched?OneChicago: is offering 85 single-stock futures contracts and 15 narrow-based indexes. On the first day of trading, 20 products that are a combination of single-stock futures and indexes will be offered.
Nasdaq LIFFE: plans to offer about 15 (10 individual names, and some additional products in the exchange-traded funds [ETFs] space). Their ultimate goal is to offer 60 SSFs during the launch period.
Are SSFs merely for speculation purposes?OneChicago: No, they can be used to transfer risk, to hedge, for arbitrage, and so on.
Nasdaq LIFFE: No, they are not merely for speculative purposes. SSFs are not all things to all investors. They are different things to different investors. Market participants may use them as speculative vehicles, hedging mechanisms, components in arbitrage strategies, investment surrogates, or alternative investments vehicles when looking at equity participation in a given equity or market segment.
How can SSFs benefit retail traders?OneChicago: Single-stock futures can be used to limit losses in their cash stock holdings, or cash/futures stock index holdings. They can also be used to enhance gains in index or other holdings. For example, if a retail customer holds one cash contract on the Standard & Poor's 500, but feels that one or two of the stocks in the index will go lower, he or she can short those stocks using single-stock futures without having to give up her cash position or worry about the uptick rule. The reverse is also true: if an investor is short the index, she can use single-stock futures to go long on the particular stocks she believes will outperform the index.
Nasdaq LIFFE: The retail trader who is informed, understands the product, and has taken the time to educate himself now has a new vehicle: one that is economically efficient, one that will broaden his trading horizon, and one that affords him another opportunity or another liquidity pool. In some instances he may find the cash underlying is the right trade. In other instances he may find it's the SSF, but this new possibility is a benefit for the retail trader. The ability to trade a futures product in a securities account or futures account opens the door for retail traders accustomed to both the futures and securities markets. It opens up new horizons, but the important starting point is education. The benefit only comes when the prospective customer understands the product.
Does the uptick rule apply for shorting?No, it doesn't.
Which exchanges will be listing SSFs?OneChicago and Nasdaq LIFFE.
How are the contracts going to be priced?Single-stock futures prices should be closely correlated to their respective cash prices. Both OneChicago and Nasdaq LIFFE are all-electronic marketplaces.
Will the introduction of SSFs have a negative effect on the cash markets?OneChicago: They are not expected to do that.
Nasdaq LIFFE: SSFs will complement the cash markets. Historically, the introduction of new derivative products has led to more vibrant underlying markets.
Jayanthi Gopalakrishnan is the Editor of STOCKS & COMMODITIES.
Originally published in the December 2002 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2002, Technical Analysis, Inc.
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