What Are Single Stock Futures?
Single Stock Futures are futures contracts with stocks of listed companies as their underlying asset and is a form of Financial Futures. Yes, Single Stock Futures provides traders and investors with an alternative, leveraged, way of speculating in the price direction of stocks.
A futures contract is a contract between a buyer and a seller, creating an obligation to enter into a transaction for the underlying asset at a fixed price. Upon expiration of the futures contract, the underlying asset, which in this case are stocks of listed companies, transfers from the seller to the buyer. This is very much like an automatic assignment in options trading. The seller of a single stock futures contract is known as the "Short Side" or simply the "short" in futures trading terms, is obligated to deliver the stocks upon expiration of the futures contract. The buyer of a single stock futures contract is known as the "Long Side" or simply the "Long" in futures trading terms, is obligated to buy the stocks from the short upon expiration of the single stock futures contract.
Due to the fact that the transaction to buy the stocks from the seller only take place upon expiration of the single stock futures contract, both parties only have to pay a small fee as deposit to secure the futures contract. This is known as the "Initial Margin" in futures trading. Being able to control the gains and losses on a large number of shares paying only a small deposit of about 20% of the total value of the stocks covered by the single stock futures contract, provides leverage. Yes, leverage is the ability to make big profits with a small amount of money but leverage cuts both ways, especially in futures trading.
Single Stock Futures Trading
Yes, single stock futures trading is a leveraged speculation on the price of the underlying stock.
The short benefits when the price of the underlying stock falls because the single stock futures contract allows the short to sell the underlying stock at a higher price. The long benefits when the price of the underlying stock rises because the single stock futures contract allows the long to buy the underlying stock at a lower price. Clearly, one would take the short side when speculating on a drop in the price of the underlying stock while one would take the long side when speculating on a rise in the price of the underlying stock.
No matter which side of the single stock futures trade you take, an initial margin is payable to the futures exchange for entering into the futures trading contract. Yes, this is unlike options trading where the short actually receive payment for the options contract that is sold. In futures trading, both the short and the long pays an initial margin for participating in the trade.
Even though the transaction for the underlying stock only take place upon maturity of the single stock futures contract, profits and losses incurred by the contracts are actually settled daily. This is a risk control measure set in place by the Clearing Houses in order to ensure that participants in the futures contract are able to fulfil their obligations upon maturity of the futures contract. This is where the risk of trading single stock futures lie. If the stock should move against your favor (upwards when you are short or downwards when you are long), losses for the day is deducted from the initial margin that you deposited when putting on the position. When that initial margin goes down to a certain level, you receive a margin call to top up the deposit to the initial margin level otherwise your position is closed in what is known as a "forced liquidation" where the broker closes your position. As such, short term volatility can be extremely dangerous if a single stock futures position is not backed up by a significant fund ready for margin calls.
Conversely, if the stock moves in your favor (upwards when you are long or downwards when you are short), profits for the day are credited to your account, increasing the deposit that you made as initial margin. Your initial margin will continue building up on a daily basis as long as the stock continues to move in your favor, creating a base of profits acting as buffer should the stock move against you temporarily. This is why good entry points in single stock futures trading is so important. It can be critical for the stock to move in your favor during the first few days of putting on the position so that a good profit base is formed to absorb losses when the stock moves temporarily against your favor.
Read the full tutorial on Futures Margin.
Due to this system of marking to market on a daily basis, you would see your account grow quickly on a daily basis should the stock move in your favor or see your account go into the red very quickly and exited should the stock move against you. This makes trading single stock futures an aggressive, dynamic and speculative activity. Even though the risks are significant, the rewards are significant as well. The example below illustrates the explosive leverage power of single stock futures.
Single Stock Futures Trading Example:
Assuming XYZ company shares are trading at $40 right now. You bought a call Single Stock Futures contract for 100 shares paying an initial margin of $800. XYZ shares rise to $50 the very next day and your account gets credited a profit of $1000. You would have made $1000 out of $400 in one day or a return of 250%. With the same $400, you would only be able to buy 10 shares of XYZ and made only $100 for a profit of 25%. See the big difference?
As Single Stock Futures are derivatives of stocks, ownership of Single Stock Futures do not grant the owner dividends or rights granted by stock ownership. This is because a person taking the long side of a single stock futures position do not own the stock itself until the contract matures and stock delivered. Always remember that all futures contracts are agreements to buy the underlying asset upon maturity, as such, holders of futures contracts don't have ownership of the underlying asset nor any any benefits of ownership until the asset is actually delivered upon maturity.
Single Stock Futures Contract Specifications
Most Single Stock Futures traded in the US market has the following general specifications:
Contract Size : 100 shares or 1000 shares
Tick Size : $0.01
Contract Months : Any month up to 2 years
Expiration Date : Third Friday of each contract month
Settlement : Physical Delivery on third business day from expiration date
Margin Requirement : 20% of cash value of contract
For details on specific Single Stock Futures contracts, please refer to OneChicago.com.
Parties In Single Stock Futures Transactions
Even though a futures transaction is theoretically an agreement between a buyer and a seller, there are really 3 parties involved in every Single Stock Futures transaction; the long, the short and the clearing house.
Single Stock Futures are guaranteed contracts. This means that both buyer and seller are guaranteed their "winnings" and there is no risk of default. This guarantee against default is made possible by the clearing house. The clearing house is the organisation that all single stock futures traders are really trading with. The clearing house puts itself in the middle of each single stock futures transaction and obligates itself to the fulfillment of all futures contracts. This provides the performance guarantee that ensures liquidity in the futures market.
When you go long or short on a single stock futures contract, the clearing house creates one new futures contract just for you. There really isn't a short side selling that contract to you. You are really trading with the clearing house. The clearing house then deposits your "winnings" or deducts your "losses" on a daily basis through the mark to market process. When you decide to close the position, the clearinghouse offsets your position with an equal and opposite transaction from another party and when you hold to maturity, the clearing house randomly selects another single stock futures trader with an opposite transaction to deliver the stocks or buy your stocks.
Because you are really trading with the clearing house and not another trader, you won't have to worry about whether that trader has the ability to fulfill on the contract at all.
Benefits Of Trading Single Stock Futures
The main benefit of trading Single Stock Futures is definitely leverage. The ability to do more with the same amount of money. Single stock futures allow you to control the same amount of stock with only 20% of the price as we have discussed above. Apart from being a leverage instrument, single stock futures can also be hedging instruments for stocks or options positions. By taking a short side on a portfolio of stocks, you effectively nullify any directional risk and this can be useful when stocks are expected to take a short term hit. Single stock futures can also be shorted to hedge against a call options position or longed to hedge against a put options position.
Another benefit of buying Single Stock Futures rather than buying the underlying stock itself is that buying Single Stock Futures allows you to keep the remainder of the cash, which would otherwise have been invested if you had bought the underlying stock itself, in the bonds markets to earn a risk free rate of return! When you buy stock, your cash can no longer generate a risk free rate of return and that loss on interest is your opportunity cost right from the start. However, if you had bought Single Stock Futures instead, you would have been able to invest the remaining 80% (assuming a 20% initial margin requirement) at the risk free rate of return and thus reduce your opportunity cost. However, this benefit is a concern mainly for investors investing very big funds. For the common retail futures traders, this is not too much of a concern.
Risks of Single Stock Futures
The single most significant risk of trading single stock futures is that fact that you can lose more than the money you initially started the trade with. If you are long a single stock futures position and the stock drops drastically in a single day, you could lose enough in one day to warrant a margin call and if you don't have enough money to fulfill the margin call, your position would not only be forcefully closed but you would also end up owing money to your broker. This is how many multi-billion dollar companies collasped overnight trading futures. As such, careful risk management in terms of leverage and cash reserve needs to be planned out when trading single stock futures.
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Where Are Single Stock Futures Traded? - Single Stock Futures Markets
Single Stock Futures are traded in many countries such as USA, Australia, Canada, Finland, Hong Kong, Spain, Sweden and UK.
In the USA, Single Stock Futures are traded in the USA through an electronic marketplace known as OneChicago, LLC. Several other exchanges such as AMEX are also looking to participate in electronic trading of Single Stock Futures (SSF) trading. In order to trade Single Stock Futures, all you have to do is open an online trading account with any of the Online Futures Trading Brokers and they will fill your orders in the respective marketplace for you. It's that simple. Most of these brokers would also support options trading because options is an important hedge for futures.
Brief History Of Single Stock Futures
Single Stock Futures started trading in the US market on November 8, 2002. Prior to 2002, trading of futures contracts on securities were disallowed as a proper regulatory authority cannot be determined. This changed in 2000 with the passing of the Commodity Futures Modernization Act of 2000, where the Commodity Futures Trading Commission and the U.S. Securities and Exchange Commission agreed to oversee and regulate the trading of single stock futures jointly. It was until 2002 when the first two single stock futures exchange started trading, one of which has closed down, with OneChicago Exchange still active today.