Futures Education

Single Stock Futures

Single stock futures (SSF's) combine the elements of two popular and useful financial investments–futures contracts and stock equity. The "commodity" or underlying product of single stock futures is, obviously, stock, or in other words, equity ownership of publically traded corporations.
You may be asking why there is a futures market for stock when there is already a healthy viable stock market? First, single stock futures offer flexibility to your portfolio by offering different strategies of managing the risks of a volatile stock market. Second, single stock futures offer exciting new ways to profit from expected price movements in an underlying company's stock. Third, single stock futures combine the advantages of the futures market with the popularity of the stock market; in other words, you take the advantages of the futures market (leverage, market hours, taxation, etc.) and combine it with the usefulness of the stock market.

Single stock futures for speculation

Let's suppose you were expecting the price of a stock to increase during a particular period of time. Instead of buying stock, you could buy a single stock futures contract. If you hold a stock position, your profit (or loss) will depend on whether the price increases (or decreases). The same is true with single stock futures, you will make money if the stock goes up and you will lose money if the stock goes down.
Conversely, let's suppose you expect the price of a stock to drop over the next couple of months. You could short the stock, or borrow stock and sell it at the current high point, and then buy it back when the market drops. Or, you could sell a single stock futures contract and offset your position by buying a single stock futures contract later after the price of the stock has dropped. When it comes to single stock futures, it is not necessary to own or borrow shares of the underlying stock in order to sell futures contracts.

Single stock futures for hedging

The foregoing examples involve speculative uses of futures contracts. But futures can also be used for the purpose of managing or limiting price risks. Let's suppose you have a large holding of Google stock which is highly susceptible to price volatility. Instead of watching your account value go up and down every quarter, you could lock in a sell price today to protect your portfolio against future price risks. We will talk about this in greater detail later in the module.

The benefits of futures in the stock market

The great thing about single stock futures is that they take all the general benefits of futures (refer to module 1) and apply them to the stock market. In other words, you get the leverage, ease of diversification, 24-hour markets, and tax benefits of the futures applied to corporate stock.

A word on risk

Before you run out and start investing in single stock futures, however, you need to know that trading single stock futures for any purpose, speculative or hedging, is not appropriate for anyone who does not understand the associated risks.
When you trade single stock futures (SSF's) you assume a level of risk greater than that of trading stock. Buying or selling futures contracts can result in losses that may substantially exceed your original investment. Although the nature and extent of risks vary, all futures trading involves risks.
The only funds that should ever be used to speculate in stock futures, or any type of highly speculative investment, are funds that represent risk capital–i.e., funds you can afford to lose without adversely affecting your financial health.You should not risk any funds that you cannot afford to lose. Retirement savings, medical and other emergency funds, funds set aside for purposes such as education or home ownership, proceeds from student loans or mortgages, or funds required to meet living expenses, should not be used to trade futures.
There are other reasons futures trading may or may not be appropriate, such as your temperament, or ability to manage your investment. Due to the leverage and volatility of futures trading generally, investing in single stock futures requires more attention and is less forgiving than trading individual stocks. Only you can determine whether this style of investing is worthwhile to you. Before you begin, make sure that you have sufficient capital, time and energy to be successful investing in single stock futures.

Differences between stocks and stock futures

While the possible uses of single stock futures are numerous and varied, you should understand that it is not the same as owning shares of the stock. Buyers of futures contracts have no ownership interests; they have no voting rights and receive no dividends. Moreover, on a stated date during the contract month, futures contracts expire; they cannot be held indefinitely in the hope of an eventual price recovery.
Single stock futures should be viewed as short-term trading instruments-whether for speculation or for risk management.
Single stock futures should not be confused with any another type of stock contract i.e. the popular stock option or stock derivative. In some circumstances, futures and options may offer alternative strategies for achieving similar goals. However, they differ in their risk and reward characteristics. Experienced investors can combine futures contracts with option contracts to create customized financial instruments with unique risk and reward characteristics. However, the two instruments are used for different purposes and are structured differently.

The single stock futures contract

Contracts for single stock futures are structurally similar to other future commodities except when it comes to the contract specifications. The following specifications are standard and consistent to all single stock futures:

• Contract Size: 100 Shares of Common Stock.
• Tick Size (min. fluctuation): $0.01
• Value Multiplier: $1.00
• Initial and Maintenance Margin: 20% of the Cash Value
• Contract Expiration: Quarterly (Mar, Jun, Sept, Dec)

How much would it cost you to purchase a single stock future contract for Caterpillar, Inc. (CAT) if it is trading at $37?

First calculate the contract value:

• Contract size * Stock Price = Contract Value
• 100 Share of Stock * $37 = $3700
  

  Second, calculate the Initial Margin or how much you will need to deposit purchase one contract:

• Contract Value * Initial Margin Requirement = Initial Deposit
• $3700 * 20% = $750

Now, let's assume Caterpillar goes up to $38.00. How much did you make?

First calculate the number of ticks:

• Increase in Stock Price / Tick Size = Total Ticks Gain
• $1.00 / .01 = 100 Ticks

Next, calculate your profit:

• Total Ticks Gain * Value Multiplier = Profit
• 100 * $1 = $100.00 profit.

Now let's assume Caterpillar goes down to $36. How much did you lose?

Again, calculate the number of ticks lost:

• Decrease in Stock Price / Tick Size = Total Ticks Lost
• $1.00 / .01 = 100 Ticks

Next, calculate your loss:

• Total Ticks Lost * Value Multiplier = Loss
• 100 * $1 = $100 loss

Now that you understand the details of purchasing a single stock future, let's compare it to purchasing the stock.
The following chart compares purchasing Caterpillar stock versus purchasing Caterpillar single stock futures if the stock goes up $1.00:

	Caterpillar Stock	Caterpillar SSF
Total Investment	$3700	$750
Total profit if stock goes up to $38.00	$100	$100
Return on Investmnt (ROI)	2.7%	13.3%

The following chart compares purchasing Caterpillar stock versus purchasing Caterpillar single stock futures if the stock stays the same:

	Caterpillar Stock	Caterpillar SSF
Total Investment	$3700	$750
Total profit if stock stays at $37.00	0	0
Return on Investmnt (ROI)	0%	0%

The following chart compares purchasing Caterpillar stock versus purchasing Caterpillar single stock futures if the stock goes down $1.00:

	Caterpillar Stock	Caterpillar SSF
Total Investment	$3700	$750
Total profit if stock drops to $36.00	-$100	-$100
Return on Investmnt (ROI)	-2.3%	-13.3%

Trading in futures can be a double-edged sword. When the market is moving in your direction, the increase in ROI can be significant. However, when it is moving against you, it can be painful.