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In the near future, investors and traders will have
the opportunity to trade single stock futures. Absolute Futures Commodity
Brokerage, in a desire to inform, as well as, educate potential traders of
Single Stock Futures, will provide information pertinent to Single Stock Futures
(SSF) as it becomes available.
The next section is an explanation, advantages, uses, margins, etc. for (SSF).
Advantages of Single Stock Futures
- With margin requirements of 20%, single stock futures provide a
highly capital efficient way to participate in equities.
- No uptick is required to establish a short position.
- 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.
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.
Trading Strategies Overview
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. Hedging Positions |
Substitution and Hedging in Individual Accounts
| Basic hedging: After large price gains, an investor may anticipate
that a stock will trade sideways for a time. Rather than selling the position,
the investor could hedge by selling single stock futures. This strategy
protects against price depreciation, while preserving ownership rights of the
underlying position. |
| Fine-tune market exposure: Single stock futures could be used to
invest in equities that might have more favorable short-term upside potential
than an investor's current holdings. Investors may fine-tune their market
exposure using security futures without changing the composition of their cash
equity portfolio. |
| Hedge 401(k) positions in company stock until the next selling period:
Covenants in benefit plans sometimes prevent the selling of equity holdings
except during prescribed periods. Individuals can use SSFs to hedge their
exposure to company stock until the next selling period. |
Volatility Hedging
Anticipated and unanticipated corporate events such as earnings announcements,
FDA rulings, mergers and acquisitions, and regulatory actions can trigger
volatility. Suppose an institution is long a technology index futures contract
and one of the companies in that index is scheduled to release its earnings
after the close. That company's price volatility may increase after the release.
Rather than selling the index and relinquishing the potential benefits from
favorable price movements, a more cost-effective alternative is to sell the SSF
on that company's stock in the amount it is represented in the index investment.
This strategy hedges the expected volatility in the narrow-based index in the
near-term.
Interest rate volatility example: Consider the example of an investor
with a portfolio of stocks for which prices have been historically sensitive to
interest rates, such as in certain sectors of the financial services industry.
Prior to an important economic announcement (e.g., the unemployment rate), the
investor might sell a narrow-based index future in that sector to hedge the
position from short-term volatility on the morning of the economic announcement.
Diversification
Diversification is a cornerstone of modern portfolio theory. Successful
diversification should in theory not only enhance returns, but also smooth their
expected path. This is the objective of most investors who construct a
sophisticated portfolio. The efficiency of security futures facilitates several
diversification strategies:
| Dynamic diversification: It is possible to efficiently execute a technical
approach that buys the highest momentum sectors and sells the lowest. |
| Pairs trading, value and relative strength investing: In pairs trading,
one firm within an industry is bought and a competitor is simultaneously sold
short. This provides an investor with exposure to the relative performance of
the two companies with limited exposure to broader market and sector
performance. |
| More broadly, relative strength investing refers to taking contrary
positions in under-performing and over-performing instruments. Typical matches
may include stocks vs. their peers; narrow-based indices vs. broad market
indices; popular index vs. popular index; and single stock future vs.
narrow-based index. This type of strategy can be efficiently implemented using
security futures. |
Sector Selection / Rotation
Since the first index products were introduced over two decades ago, many
investors and money managers have come to believe that sector selection, rather
than individual stock selection, is a key determinant of investment returns.
Narrow-based indices are designed to reflect a specific market sector and will
contain nine or fewer equities. Examples of industries and industry sectors
might include:
| Energy
- Natural gas, Transmission, Extraction services, and High technology
companies |
| Personal computer makers
- Computer storage, Database software, Security, and Online markets |
| Health care providers
- HMOs, Pharmaceuticals, and Hospital operators |
| Telecommunications
- Wireless, Networking, and Infrastructure |
Narrow-based indices as an alternative to mutual fund switching
Mutual fund switching has become popular with certain investors that use
technical and fundamental analysis to guide sector-based investment decisions.
As the strategy grew in popularity, however, most mutual fund companies limited
and/or charged substantial fees to those who wanted to actively switch among
sector funds. Futures on narrow-based indices may provide an effective
alternative to re-balancing a portfolio.
Managing Expiration Dates
All futures contracts have expiration dates. There are three basic approaches
for managing the expiration of futures contracts:
Offset your position: Prior to expiration, you may offset by covering (buying
back) a short position or selling a long position. You don't have to wait until
the expiration date to complete your trade. Many investors choose to offset
equity futures positions before expiration.
Wait until the contract expires, then make or take delivery: On the expiration
date, holders of short positions of stock futures are required to deliver
physical shares of the underlying stock, and holders of long positions take
delivery of the underlying stock. This means that buying a single stock future
and holding it until expiration, provides you ownership of the underlying stock
after the expiration date. If you are considering holding a stock futures
contract until expiration, consult your brokerage firm regarding its procedures
and fees associated with delivery. If you offset your position, this process
does not apply.
Roll the position over from one contract expiration into the next: If you hold a
long position in an expiration month, you can simultaneously sell that
expiration month and buy the next expiration month for an agreed-upon price
differential. Thus the position is transferred, or
rolled forward, and can be held for a longer period.
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.
Security Futures Margin Requirements
Margin Requirements Highlights
| The basic margin requirement for security futures is 20% of the underlying
value of the contract (initial and maintenance margin). |
| This 20% minimum may be reduced for certain types of futures market
positions, such as calendar and basket spreads, and for certain offsetting
positions in stock options and cash securities, provided the security futures
are held in securities accounts. |
| Margin requirements can be satisfied with cash, margin securities, and
open trade equity in other futures accounts. |
| Certain industry professionals (such as qualified market makers) are
exempt from these requirements. |
| Portfolio-based margining (e.g. SPAN margining) is not yet permitted for
customer positions in security futures. Firms will nonetheless continue to
receive SPAN files that reflect the appropriate minimum margin requirements.
You should be aware that trading futures involves the
risk of loss, including the possibility of loss greater than your initial
investment. Stock futures may not be suitable for all investors. Consult your
broker or financial advisor before trading.
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