AT THE CLOSE
An Update On Single-Stock FuturesNow that single-stock futures (SSF) have been trading for more than four years, we have had an opportunity to see how they have developed and observe some of the changes that have occurred as a part of a growing new market. Several notable changes have taken place since they began trading in November 2002. One of the two original exchanges, NQLX, is gone, leaving OneChicago as the only exchange offering these products. From the outset, OneChicago was the clear leader, so that should come as no surprise. The only advantage I saw that NQLX offered over OneChicago was a contract length out to 15 months, and frankly all of my single-stock trades have been of a much shorter duration.
Another big change is that the microsector indexes, which never were offered by NQLX, have been shelved for the time being by OneChicago. They have not been eliminated and, as explained to me by the nice folks there, will be brought back any time there appears to be a demand for them. In addition, the exchange is actually offering custom-designed indexes for specific institutional traders based on specific demand, but I will restrict this discussion to single-stock futures.
Although overall volume has been steadily increasing, there still seems to be a reluctance to trade these products by many people. Futures traders are still the majority of those using these products, but according to OneChicago, the biggest increase in usage may be coming from institutional stock traders as more brokerages become familiar with them. You can trade single-stock futures from either a futures or equity account, but not all stock brokerages offer them. There still may be some hesitation on the part of primarily stockbrokers because they trade more like futures, and hence are still somewhat unfamiliar to the stockbroker.
QUICK REVIEW
For those unfamiliar with single-stock futures, each contract is for 100 shares of a particular stock. They are primarily large-cap stocks with nearly 500 currently being offered. You put up a margin of 20% of the value of the 100 shares. For example, if Apple [AAPL] is trading at $85 per share, each contract of 100 shares is worth $8,500, so you put up $1,700 to control 100 shares of AAPL. If the price goes up to $90, you made $500 on your $1,700 investment as opposed to $500 on an $8,500 investment.
So why wouldn't everyone do it this way? Well, there are a few problems with trading SSF. First of all, let's say you are a momentum trader, and you generally enter an order to buy a stock if it hits a certain price. Single-stock futures, like all futures, have multiple contracts that extend into the future, so the price on a contract that is three or six months out will not be the same as the current price.
Here's an example. If in December Microsoft [MSFT] were currently selling at $29 per share, the March contract may be selling for $30.50 or more. If you want to get in if MSFT hits $29.25, there's really no way to enter a buy-stop on a single-stock future. So you have to watch the market (or set an alert) and when your target price is hit, you have to enter your buy order on the single-stock future. This is further complicated by the fact that -- and this is where futures traders get twisted around -- there is a bid and an ask, just like stocks.
So when MSFT hits $29.25, the March contract may have a bid of $30.40 and the ask might be $30.55. The bid and ask are also generally wider in SSF than they are on the underlying. If you enter an order in between, there is no guarantee you will get filled. In fact, I have entered orders to buy at the asking price and not been filled. As the markets rise, the bid and ask go higher and you end up chasing the market. If you enter an order to buy at the market, you generally get filled right away, but often outside the range of the bid and ask.
In the preceding example, you may get filled at $30.58. This shouldn't be too much of a problem, but you need to be aware that fills are not going to be as predictable as in the cash market.
Personally, I trade for short-term trends (two weeks to several months) and have not been disappointed with my fill prices. The market maker system of OneChicago originally guaranteed a constant two-sided market with a lead market maker (LMM) for each contract. Now, however, there are some contracts with no lead market maker, and OneChicago is clear to point out that there may not be a continual offering of bid and ask prices on certain stocks. They add, however, that they have had no negative feedback as a result of not having a LMM.
Until a few months ago, the number of stocks offered as single-stock futures was rather limited. As of this writing, however, there are close to 500 being offered and more planned. This is creating more opportunities, as there are now stocks in more diverse sectors than previously. This is ideal for my particular trading strategy, as I tend to keep my trades short term and rotate from sector to sector.
One of the biggest advantages from the beginning was that you were able to short these products easily; no need to wait for an uptick, no need to borrow shares, and no broker loan fees to pay. So I move from sector to sector, going long the strong ones, and shorting the weaker ones. I have both long and short positions at the same time, and since the margin requirement is so small, it doesn't take much of a move to realize a respectable profit.
Another advantage with the introduction of more offerings is that you can spread similar stocks. For example, you could spread Home Depot vs. Lowe's, or Boeing vs. Lockheed Martin, or Centex vs. Pulte Homes. The possibilities are endless. With such a small margin requirement, a small improvement in the spread between two stocks could result in a worthwhile trade.
While single-stock futures still have a way to go before they rival the trading volume of other products, they remain a viable trading instrument with many advantages. I am surprised more institutional investors have not embraced these as an additional tool in their portfolios, and I am certain it is only a matter of time before they do.
When the markets become stagnant or choppy as they tend to, institutional investors will have to do more to create positive returns if they want to beat the indexes and stay ahead of the competition. Using single-stock futures to enter short positions or temporarily hedge long positions through intermediate corrections should become more commonplace.
More activity means more liquidity, and more liquidity means narrower spreads and better fills. These products are here to stay, and those traders who take advantage of what they have to offer will have a distinct advantage over those who do not.
Jeffrey Seyler is president of Sahara Trading Co., a Cpo and Cta in Winter Park, FL. He has been a trader of stocks, futures, and options since 1980, and currently manages a commodity pool that trades primarily single-stock futures. He may be reached at jseyler53@hotmail.com.
Originally published in the April 2007 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2007, Technical Analysis, Inc.
Return to April 2007 Contents