A ONE-STOP PORTAL OF INFORMATION FOR FUTURES AND COMMODITIES TRADERS
SINGLE STOCK FUTURES(SSFs):
THE BASICS A SSF contract is simply a standardized agreement between two parties to buy or sell 100 shares of a particular stock in the future at a price determined today. Futures contracts are bought and sold on federally regulated exchanges, and for SSFs, regulation is by both the Securities and Exchange Commission and the Commodity Futures Trading Commission.
HOW THEY TRADE The mechanics of trading SSFs are fairly straightforward. If you believe that the price of a particular stock will go up, you buy or "go long" a SSF contract. If you think the price is headed down, you sell or "go short" the futures contract (and in futures trading, you don't have to wait for an uptick as you might have to when shorting stocks, so going short is as easy as going long). As an example, let's say you bought an April futures contract on XYZ Company at a price of $50 during the first week of February. This gives you the obligation to buy XYZ at $50 when the future expires on the third Friday of April unless you sell the futures contract first. In other words, you can end your agreement to buy XYZ by selling the April futures contract at any time before the contract ceases trading. If XYZ's price at the time is greater than $50, you make $100 for each dollar it is higher, and you lose $100 for each dollar it is lower. The procedure for selling is just the opposite. You can offset your obligation at any time on a short contract by buying it back before you would need to deliver XYZ shares. If XYZ's price at the time is less than $50, you'll make $100 for each dollar it's lower, and you'll lose $100 for each dollar it's higher.
PROFITS AND LOSSES If you sell a futures contract at a higher price than you bought it, you'll make money. If you sell it for less than you bought it, you'll lose money. It doesn't matter whether you first went long or short. The formula is the same:
[Price Sold - Price Paid] x 100 shares x Number of Contracts = Profit or Loss
Let's say you went long (i.e., bought) 5 contracts of XYZ futures at $50 and sold them one month later at $55. Your profit will be:
[$55 - $50] x 100 shares x 5 = $2,500
If, however, you went short 5 contracts of XYZ at $48 and bought them back at $57, your loss would be:
[$48 - $57] x 100 shares x 5 = ($4,500)
These calculations don't include commissions paid to your broker. As in stock trading, the cost of commissions are subtracted from your profits to determine your net profit or added to your losses to determine your total loss. You should also be aware that futures brokers may calculate commissions on a round-turn basis-that is, commission covers both the cost of opening and closing a position. Stock commissions are typically calculated separately for each side of a transaction.
SIMILARITIES AND DIFFERENCES SSFs have the same price and risk profiles that are familiar to stock traders. But there are differences. The most important difference is that you are separating the pricing of the stock from the time when you actually buy or sell it. As a result, the mechanisms for accounting for gains and losses and for assuring that the parties involved pay for those losses, are different in futures trading than in stock trading. In futures trading, whether you take a long or a short position, you'll be asked to post some funds with your broker. This, however, is not for the purpose of paying for or receiving payment for the stock; if you have a long position, you haven't bought anything yet, and if you have a short position, you haven't sold anything yet. You will be asked to post a sum of money known as "initial margin"-- a good faith deposit that provides assurance that you can meet your obligations if your futures position moves against you. The minimum initial margin level is set by government regulations, but your brokerage firm may ask for more than the minimum if its own risk analysis requires it, or to provide more cushion before a margin call is triggered. Exchanges can and do raise and lower margin levels in response to market conditions. Gains and losses are posted to your account every day-gains in the case that you are long and the price of the stock goes up; losses when you are long and the price of the stock goes down. The short position has the opposite gain and loss profile. Again, to assure that you can meet your obligations, you may be required to post additional margin should the value of your account fall below a pre-determined maintenance level. If your account falls below the minimum maintenance level, you will be asked to bring your account all the way back up to the initial margin level, rather than simply up to the maintenance level. Trading on margin in the stock market is different than in the futures market. When you buy stock on margin, you are borrowing from your broker in order to purchase the stock and using the stock you purchase as the collateral for the loan. You also pay interest to your broker for the loan. When you short a stock, you are borrowing stock from your broker, and you pay your broker the broker loan rate plus any dividends due. But the futures trader has not borrowed to buy stock nor has borrowed stock to sell. There is no interest on a loan involved. In the world of futures, the margin obligations of buyer and seller are the same: to deposit funds in order to ensure that their obligations can be met. Single stock futures are different than stock options and are considered by many traders to be easier to understand. If the stock price goes up, the futures price will go up, except in extraordinary circumstances. Options, on the other hand, exhibit non-linear behavior over time, price, and volatility. What that means, simply speaking, is that there are many considerations that go into pricing options, and many options traders have had the experience of watching options positions head in a direction opposite to what they might expect, or not move at all.
MARGINS AND LEVERAGE Whatever the initial margin level is at any given time, remember that margin can be your best friend or your worst enemy. For the sake of example, let's assume an initial margin level of 20% in our examples of: 1) going long a single stock futures on ABC Company at a $50 trade price and closing your long position at $55, or 2) going short a single stock futures contract on ABC Company at a $48 trade price and closing your short position at $57. The margin level represents 20% of the value of the contracts traded for calculating the return on initial margin in these two trades.
o Example of going long at $50 and closing the position at $55:
Initial Margin at $50: [20% x $50] x 100 shares x 5 contracts = $5,000
Gain on position if closed at $55: $2,500 Return on margin: $2,500/$5,000=50.0%
o Example of going short at $48 and closing the position at $57:
Initial Margin @ $48: [20% x $48] x 100 shares x 5 contracts = $4,800 Loss on position if closed at $57: ($4,500)
Return on margin: ($4,500)/$4,800 = (93.75%)
The importance of this illustration cannot be emphasized enough: In futures trading, you can lose more than your initial margin deposit. Never base the number of contracts you trade on the level of the initial margin. If you have not traded futures before, consult your broker or financial advisor about the risks involved.
