What Is Single Stock Futures?
Single stock futures (SSFs) are a type of derivatives contract where two parties agree to exchange a specified number of shares of a particular stock for a price agreed upon today, with delivery occurring at a specified future date. As futures contracts, single stock futures obligate both the buyer to take delivery and the seller to make delivery of the underlying asset, typically 100 shares of the chosen equity, at the contract's expiration. This mechanism allows market participants to speculate on the future price movements of individual stocks or to employ hedging strategies against existing equity positions.
History and Origin
The evolution of single stock futures in the United States has been marked by significant regulatory developments. For many years, a prohibition on trading futures contracts based on single securities existed in the U.S., largely due to jurisdictional disputes between the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC). This changed with the passage of the Commodity Futures Modernization Act (CFMA) in December 2000, which lifted the 18-year ban and provided a framework for the regulation of these products.5 Following the CFMA, single stock futures began trading in the U.S. in 2002, subject to the joint regulatory oversight of both the CFTC and the SEC.3, 4 Despite initial expectations, their trading volume in the U.S. remained modest compared to other derivatives. The last exchange that listed single stock futures in the U.S., OneChicago, ceased operations in September 2020.2 While their trading ceased in the U.S. market, single stock futures continue to be traded on various international exchanges.
Key Takeaways
- Single stock futures are derivative contracts that obligate parties to buy or sell a specific number of shares of a particular stock at a predetermined price on a future date.
- They allow for both speculation on stock price movements and hedging of equity portfolios.
- Single stock futures offer significant leverage, enabling control over large positions with a relatively small capital outlay, known as margin.
- In the U.S., their trading was legalized by the Commodity Futures Modernization Act of 2000 and jointly regulated by the SEC and CFTC.
- The U.S. market for single stock futures ultimately faced challenges with achieving sufficient liquidity.
Interpreting the Single Stock Futures
Understanding single stock futures involves recognizing their nature as binding agreements. When an investor takes a long position in a single stock future, they are committing to purchase the underlying asset at the agreed-upon price on the expiration date. Conversely, taking a short selling position means committing to sell the underlying stock. The price of a single stock future reflects the market's expectation of the underlying stock's price at the contract's expiration. Unlike owning the actual stock, holding a single stock future does not confer voting rights or dividend entitlements. The interpretation centers on the price differential between the futures contract and the spot price of the stock, as well as the expected direction of the stock's price movement.
Hypothetical Example
Consider an investor who believes that Company XYZ's stock, currently trading at $100 per share, will increase in value over the next three months. Instead of buying 100 shares outright for $10,000, the investor could enter into a single stock futures contract.
Let's assume a single stock futures contract for Company XYZ, with an expiration in three months, is priced at $101 per share. Each contract typically represents 100 shares, so the total contract value is $10,100. The investor takes a long position, committing to buy 100 shares of Company XYZ at $101 in three months. The initial margin requirement might be, for example, 20% of the contract value, or $2,020. This allows the investor to control a $10,100 position with a smaller upfront capital outlay, demonstrating the leverage inherent in futures trading.
If, at expiration, Company XYZ's stock price rises to $105 per share, the investor can realize a profit. The investor effectively buys at $101 and the market value is $105. This results in a profit of $4 per share, or $400 for the 100 shares per contract size, minus any brokerage fees. If, however, the stock price falls to $95, the investor still must buy at $101, incurring a loss of $6 per share, or $600 per contract, plus fees. This example highlights both the potential for amplified gains and losses with single stock futures.
Practical Applications
Single stock futures offer various practical applications for investors and traders, predominantly in the realm of derivatives trading. They can be used for:
- Speculation: Traders can take long or short positions to profit from anticipated price movements of individual stocks. This allows for capitalizing on both rising and falling markets without direct stock ownership.
- Hedging: Investors holding a portfolio of stocks can use single stock futures to protect against potential declines in value of specific holdings. For instance, an investor with a substantial holding in a particular stock might sell single stock futures on that stock to offset potential losses if the stock's price falls.
- Arbitrage: Opportunities may arise from price discrepancies between the spot market for a stock and its corresponding single stock future, allowing sophisticated traders to profit by simultaneously buying and selling to exploit these differences.
- Leveraged Exposure: Single stock futures provide leverage, meaning a relatively small amount of capital can control a large position in the underlying stock. This can amplify returns but also magnify losses.
Despite their potential uses, FINRA, the Financial Industry Regulatory Authority, notes that single stock futures involve a high degree of risk and are not suitable for all investors.1
Limitations and Criticisms
While offering unique trading opportunities, single stock futures have several limitations and have faced criticisms, particularly in the U.S. market. A primary concern is the significant leverage involved, which can lead to substantial losses that exceed the initial margin deposited by the investor. Unlike equity ownership, single stock futures do not grant shareholders voting rights or dividends from the underlying company.
Another criticism, particularly evident in the U.S. market, has been the challenge of generating sufficient liquidity. Despite the legalization of single stock futures by the Commodity Futures Modernization Act of 2000 and the establishment of joint regulatory oversight by the SEC and CFTC, trading volumes in the U.S. never reached the levels seen in some other markets. This lack of robust trading activity on U.S. exchanges, such as OneChicago which eventually closed, limited their effectiveness for large institutional investors and contributed to their eventual discontinuation in the U.S. The dual regulatory structure, while intended to provide clarity, also presented unique compliance challenges for brokerage firms and exchanges. Furthermore, investors often found alternative derivatives products like options to be more familiar or more liquid for similar speculative or hedging purposes.
Single Stock Futures vs. Options
Single stock futures and options are both derivatives that allow investors to gain exposure to an underlying asset without outright ownership, and both can be used for speculation or hedging. However, they differ fundamentally in their obligation and risk profiles.
| Feature | Single Stock Futures | Options |
|---|---|---|
| Obligation | Both buyer and seller have an obligation to fulfill the contract at expiration. | Buyer has the right, but not the obligation, to exercise. Seller (writer) has the obligation if the option is exercised. |
| Leverage | High, due to margin trading. | High, as a small premium controls a larger asset value. |
| Risk | Potentially unlimited loss for both parties. | For the buyer, risk is generally limited to the premium paid. For the seller, risk can be unlimited (for uncovered calls) or substantial (for uncovered puts). |
| Profit/Loss Profile | Linear relationship to the underlying stock's price movement. | Non-linear; influenced by strike price, time to expiration, and volatility. |
| Daily settlement | Yes, gains and losses are settled daily. | No daily settlement of gains/losses on the option contract value itself. |
Confusion often arises because both instruments provide leveraged exposure to individual stocks. However, the binding nature of single stock futures, where both parties are committed to the transaction at expiration, contrasts sharply with the optionality of an options contract, which grants a right but not an obligation to the holder. This distinction is crucial for understanding the differing risk and reward characteristics.
FAQs
Are single stock futures traded in the U.S.?
No, as of September 2020, single stock futures are no longer traded on exchanges in the U.S. The last exchange that listed them, OneChicago, ceased operations. While legal, no U.S. exchange currently offers them.
What is the role of a clearinghouse in single stock futures?
A clearinghouse acts as an intermediary for all single stock futures transactions, guaranteeing the performance of both parties to the contract. It reduces counterparty risk by becoming the buyer to every seller and the seller to every buyer. The clearinghouse also manages the daily settlement process, where gains and losses are realized and accounted for each day.
What are the main risks of trading single stock futures?
The primary risks include unlimited potential losses (especially for short positions), significant leverage that can amplify losses beyond the initial margin deposit, and the potential for a lack of liquidity in the market, which can make it difficult to enter or exit positions at desirable prices.
How are single stock futures regulated?
In jurisdictions where they are traded, single stock futures are typically subject to joint regulation by both securities and futures regulatory bodies. For instance, in the U.S. when they were traded, they fell under the joint jurisdiction of the SEC and the CFTC. This dual oversight ensures that the products comply with regulations governing both securities and futures contracts.