It was not until November 8, 2002 that the United States opened their financial doors to single stock futures. Needless to say it was big news, one of the most anticipated financial news in the world.
Single Stock Futures have been traded for some time in the London Financial Futures and Options Exchange, now part of Eurnext.liffe, the international derivatives business arm of Euronext.
What are single stock futures? They are future contracts that are based on single stocks and not on physical or financial commodities. Let’s begin with what a futures contract is? A futures is a contract to buy or sell a product at a certain price at a specific time in the future. This is a binding contract. If you purchase a future and the assigned time to pay for it arrives and you have not sold it you are required to pay and receive the physical (corn, oil, steel) or financial (bonds, stocks) commodities you bought.
Single stock futures do the same thing all futures do, that is to fix the price at a future date, but in this case it is stocks that are being sold not soya beans or gold. One single stock future represents 100 shares of a company’s stock. If you purchase a single stock future in a company and the future expires you will be forced to buy it at the agreed price. In a similar way to other futures, SSFs have specific expiration months, March, June, September and December, these are busy months for speculators that want to sell their futures before they expire.
There are two kinds of single stock futures traders, speculators and hedgers. Speculators buy stock futures because they think the share price of a company will increase and sell when they can make a profit on their lower stock price.
Hedgers on the other hand will purchase futures because they really want to own the stock. This can be done as a way to secure a stock position. For instance, if a put or call seller has sold stock options on a stock for a certain price he can buy futures of that stock at a price that will cover his costs if he is assigned to provide the stock at the put or call price.
At the moment there are around 115 stock futures that are traded. These are blue chip companies that have an outstanding record or are very likely to be profitable. This exclusive list includes companies like Microsoft, IBM, Johnson & Johnson and Citigroup.
So what is the difference between buying stock futures and outright stock? To start with the price of stock and its future will generally not trade at the same price. There is a formula that determines the price of a single stock future.
SSF = Stock price x (1 + time to expiration x interest rate) – dividends.
The price of SSFs is normally higher than the stock price because of the extra leverage they provide. Another advantage is that stock futures are cheaper to trade with. This is because when buying a future you do not have to put forward the entire price of the stock but only a margin or small portion. This margin is generally around 20 percent of the cash value of the stock you are purchasing, or promising to purchase.
Option traders love stock futures because they easier and cheaper to trade with. Even for traders in stock they are a great tool because of the added leverage they provide. If you purchase single stock futures wisely you can profit from them whether the stock price moves higher or lower in price. Needless to say this is a great way of managing the risk of trading on the stock market.
