Security Futures Overview

Security futures is the term used to collectively describe futures on individual stocks and futures on narrow-based indices. These products are now being introduced into the U.S. and represent an important new tool for professional traders. Security futures enable money managers, proprietary trading operations, and other investors to efficiently execute a variety of trading strategies for U.S. listed equities. To learn more about Security Futures, read the online Futures Magazine publication Security Futures: Finally the Next Big Ticket.

Single stock futures (SSF) are futures contracts on individual stocks. Initially, futures on 80 to 85 well-known stocks such as IBM, Qualcomm and Microsoft will be listed. In late 2000, the U.S. Congress passed legislation lifting the ban on these products, which were already trading in Europe and elsewhere.
 
A single stock futures contract is an agreement to deliver shares of a specific stock at a designated date in the future, called the expiration date. At all times, four expiration dates will be available for trading single stock futures.

The size of a single stock futures contract is 100 shares of the underlying stock.

When a security future is traded, both the buyer and seller put up a good faith deposit called margin. Margin requirements are generally 20% of the cash value of contract, 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.

Security Futures Pricing - Single stock futures prices generally conform to a theoretical pricing model based on the following formula:

 Futures price = stock price x (1 + annualized interest rate - dividend)

Futures will typically trade at a premium to the stock price because of an adjustment for interest rates. The premium reflects the interest earned on the capital saved by not posting the full value of the underlying stock. Since futures holders are not entitled to collect dividends, the futures price must be adjusted downward by the present value of the dividend payments expected prior to expiration. When a large dividend payment is forthcoming or if the underlying stock is difficult to borrow, the futures price may trade at a discount to the actual cash price.

Narrow-based indices are futures contracts on small groups of stocks that allow an investor to take a position in a concentrated area of the equities market. Each narrow-based index will typically include three to nine companies in a specific sector. Initially at least 15 narrow-based indices on key economic sectors such as Airlines, Computers, Investment Banking, and Semiconductors will be listed. For more information about Narrow-based indices, read the Futures Magazine article Narrow-based Indexes: Pick a Sector, Any Sector.

Advantages of Single Stock Futures

1. With margin requirements of 20%, single stock futures provide a highly capital efficient way to participate in equities.

2. No uptick is required to establish a short position.

3. Short sellers may benefit from eliminating the costs and inefficiencies associated with the stock loan process.

Advantages of Narrow-Based Indices

Using these indices, investors can take a long or short position in a concentrated basket of stocks without incurring multiple transaction fees.  This structure allows difficult-to-execute or advanced investing strategies such as spread trading or sector rotation to be executed swiftly and cost efficiently, as narrow-based indices are also subject to a margin requirement of 20% of the cash value of the contract.

Range of Trading Strategies

Single stock futures are used with a broad range of trading strategies and can be applied to a variety of portfolio management needs.  Since the price of an equity future typically tracks the price of the underlying instrument nearly tick for tick, trading strategies used in the stock market today should be transferable to the stock futures market.

Electronic Trading

Security futures trading can be fully electronic.  Trade processing and clearing are fully automated using state of the art technology.

Choice of Brokers and Accounts

Single stock futures and narrow-based indices may be traded in either a securities account or a futures account.  Individual investors will be able to trade single stock futures on their PCs through their securities or futures brokerage accounts.

 Trading Strategies

Many existing strategies in use in the stock market today may also be applicable to single stock futures and narrow-based indices. Here are examples of how these products can allow investors and portfolio managers to inexpensively execute a wide range of trades:

·   Protect a long equity position against price volatility or short-term downward movements.

·   Use futures as an inexpensive alternative to purchase a stock, and then take delivery of the underlying stock to augment your portfolio

·   Use narrow-based indices to invest cost-effectively in specific economic sectors

·   Trade long/short pairs.

·   Use single stock futures as a cost-effective hedge for stock options positions

·   Continue using the analytic approaches you currently employ for investment decisions in stocks or futures (such as technical analysis, chart-based strategies, and fundamental analysis)

Some of the specific uses of security futures may include:

·   Long or short directional trades: Security futures provide the advantage of capital efficiency for taking long or short positions in specific securities.

·   Index hedging: The growth of broad-based index investments in the S&P 500 and other benchmarks has experienced tremendous growth as a strategy to reduce the risk of under-performing the market. SSFs provide a means to remove a stock from an index investment by shorting the undesired security using a futures contract. Investors can fine-tune an index approach by adding narrow-based indices to gain added exposure to sectors exhibiting relative strength.

·   "Portable alpha" trading: Single stock futures and narrow-based indices will expand opportunities for "portable alpha" strategies that are used by some institutional investors. In this strategy, a money manager hedges out some or all of the fund's exposure to a less desirable asset class or market sector by shorting an index future in that asset class or sector. The sponsor or manager then buys futures contracts in a more desirable asset class or market sector.

Customers wishing to trade Narrow Based Indexes  and Single Stock Futures Products, must contact Commodity Futures Trading, 1-800-241-0339 to obtain a copy of the required Security Futures Product’s Risk Disclosure Statement. You must also down load the required risk disclosure statement from http://www.nfa.futures.org/compliance/sfp_disclosure.pdf.  Narrow Based Indexes and Security Futures Products are not suitable for all investors. The risk of loss associated with these products can be substantial.

 
This material has been prepared for first use on December 10, 2002.

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Last modified: October 08, 2007