Single stock futures (SSF) are binding contracts between two individual investors. The buyer of the contract has the legal obligation to purchase 100 shares of a certain stock at a predetermined price at a specific time in the future. In turn, the seller of the contract pledges to deliver the 100 shares of the stock at the agreed price on the specified date in the future. The mechanics of trading single stock futures works in a similar way to trading commodity futures. Investors can benefit from the performance of a particular stock without having to own the asset.
Like the commodity futures contract, a single stock futures contract is standardized. Each contract follows exact specifications, including contract size, expiration cycles, and tick size. There are also stipulations regarding the last trading day and margin requirements. Currently, the contract size is 100 shares of the underlying asset. The expiration cycle is based on four quarterly expiration months. There are also two months, called “serial months,” which are not based on quarterly expiration.
Each standardized contract has a tick size of $0.01 US Dollars (USD) per share or $1 USD per 100 shares. The contract expires on the last trading day, which is usually the 3rd Friday of the expiration month. All traders must meet margin requirements, which is typically 20 percent of the cash value of the stock. All contracts call for the seller to deliver the stock to the buyer at a certain date in the future. The fact is,the majority of contracts are never held by the buyer until expiration. Typically, the contract is offset before the last trading day.
The uniformity of SSF contracts makes them reasonably easy to liquidate. Investors can relinquish a contract by taking an offsetting position. For instance, to liquidate a short position, the trader simply purchase a long contract. To offset a long position, the investor goes short. SSF investors, whether they are sellers or buyers, are required to put up a margin deposit toward the purchase of a contract. This amount is generally 20 percent of the stock's worth toward the purchase of the contract. This “good faith deposit” is held by the brokerage firm and is applied when the contract is settled.
The 20 percent margin requirement is stipulated by federal regulations. Brokerage houses have the authority to require investors to pay a higher margin. Traders must maintain the amount for margin requirement in their account on a continuous basis. The margin requirement for each condition is computed on a daily basis by the broker. If the accounts decline below the minimum requirement, investors are required to deposit additional funds in the account.
Unlike the purchase or shorting of stocks, an investor who buys single stock futures is not borrowing money to fund the purchase; therefore, the trader does not have to pay interest. Conversely, the seller who shorts the stock is not borrowing the asset. Many traders invest in single stock futures as part of a strategy to hedge their stock positions. This tactic ensures protection against any losses the investor may incur on stock purchases.
