Futures Education

Strategies using Single Stock Futures

The most common use of single stock futures in trading is speculation. However, single stock futures can be bought and sold for myriad reasons and in different combinations to meet different objectives. The following describes just a few of the trading strategies used by single stock futures traders:

Long SSF Trade

In this trade, your objective is to profit from a price increase in the underlying stock.

Short SSF Trade

Here, your objective is to profit from a price decrease in the underlying stock.

SSF Relative Strength Trade

In the relative strength trade, you hope to profit from one stock's price performance relative to another stock's price performance.

SSF Short Hedge

In this trade you use single stock futures to protect a long stock position against the risk of downward price movement.

SSF Long Hedge

A long hedge in single stock futures allows you to set the purchase price of a long stock position today - even though you won't actually buy the stock for days or weeks.

SSF Portfolio Hedge

You can temporarily alter your portfolio's composition without having to acquire or liquidate shares of stock.

SSF Arbitrage

Arbitrageurs profit from imbalances and inefficiencies between the stock price and the single stock futures price.

SSF and Equity Option Combinations

Many single stock futures traders actually combine SSF's with equity options to create investments with unique risk and reward characteristics.
Before you begin to trade any of these strategies remember, heed these words of caution:
You may notice that each strategy listed above has a specific objective and motivation. It is important when trading single stock futures that you use the right strategy for the right purpose. The consequences can be dire if you make a mistake and use a hedging strategy for speculative purpose, or if you use an arbitrage strategy for a speculative purposes. Before you trade, make sure you understand your setup and use the appropriate strategy.
Another common challenge is the tendency to change strategies in the middle of a trade. Successful traders set a plan and trade their plan. The market has a knack for enticing you to change your mind. Do not fall for this trickery!
Finally, by no means is this a complete list of strategies used by single stock futures traders. These are simply the most common strategies. You can, for example, increase the level of complexity significantly when you start combing SSF's with equity options or if you use SSF's to manage portfolio risk. However, these are topics for a later time.
Let's start out with the most simple and straightforward use of single stock futures: the Long SSF Trade.

Long SSF Trade

The long SSF trade is the most simple of all the strategies using single stock futures. It is akin to buying stock outright in terms of analysis and objective. You want a stock that is in an uptrend. You want to buy the SSF at support and sell at resistance. If the stock increases in value, your contract will increase in value - dollar for dollar. The risk, of course, is that a stock price decrease will result in a dollar-for-dollar loss.

Example

Stock ABC is priced at $50 a share and you expect it to increase. You purchase a 100-share May futures contract at a price of $50.00 a share. Assuming the required initial margin deposit is 20%, your initial outlay is $1,000. Your gain or loss will depend on what happens to the futures price.

If the futures price when the contract is sold is $45, then you have a loss of $500 on the futures contract.
If the futures price when the contract is sold is $50, then you break even on the futures contract.
If the futures price when the contract is sold is $55, then you have a gain of $500 on the futures contract.

You will notice that you make money when the stock price goes up and you lose money when the stock price goes down. This is the same risk structure as buying the stock. If you buy stock and the stock goes up, you make money. If you buy stock and the stock goes down you lose money. There is really no difference between buying the stock and purchasing the SSF except in your capital outlay.

The Short SSF Trade

If your forecast for a particular stock is gloomy, you can initiate a short SSF trade by selling the stock's SSF. As the stock price drops to your target, you can then offset your short position by purchasing a similar contract with the same expiration.
In many ways, a short single stock future position can be less cumbersome and usually less expensive than establishing a short position in the stock itself (i.e., by acquiring and selling shares of borrowed stock). There are no complicated short selling rules to worry about and you don't have to pay interest on the borrowed stock.
Your decision to sell a SSF may also be influenced by general stock market conditions. If the markets are falling fast, your broker may not be able to accommodate a short stock sale for your account due to a rule in the stock market that forbids short sales without first having a move higher. This is called the uptick rule and it can limit your profitability in the bearish stock market. The good news is that there is no uptick rule in single stock futures.
Furthermore, short futures positions do not require your broker to locate and borrow the underlying stock prior to execution. They simply sell your single stock futures contract - after all, you've put up a good faith deposit letting them know you'll fulfill your end of the contract or at least offset it before it expires. Whereas buyers of futures contracts seek to benefit from price increases, sellers of futures contracts seek to benefit from price decreases and stand to incur losses if the futures price rises rather than falls.

Example

In January the price of XYZ stock is $50 a share and the May futures price is $50.00. Expecting the price to decline, you sell a 100-share futures contract at $50.00 and make a margin deposit of $1,000.

• If the futures price when the contract is bought is $45, then you have a gain of $500 profit on the 100-share futures contract.
• If the futures price when the contract is bought is $50, then you break even on the 100-share futures contract.
• If the futures price when the contract is bought is $60, then you have a $1000 loss on the 100-share futures contract.

The Short SSF trade is a great alternative to short selling and can provide a great way to make money in a bear market.