Single-Stock Futures [CapiPedia]

This page is read only. You can view the source, but not change it. Ask your administrator if you think this is wrong.
======Single-Stock Futures======
A single-stock future (SSF) is a type of [[futures contract]] where the underlying asset is a specific number of shares of a particular stock. Think of it as a binding IOU for stocks. The buyer of an SSF contract is legally obligated to purchase a set number of shares (typically 100) at a predetermined price on a future date, while the seller is obligated to deliver them. These instruments are traded on regulated exchanges and are marked by their significant use of [[leverage]], meaning an investor only needs to put up a small fraction of the contract's total value as a deposit, known as [[margin]]. This feature dramatically magnifies both potential gains and, more importantly, potential losses. While they have existed globally for some time, SSFs were re-legalized for trading in the United States in the year 2000, but they have never achieved the same popularity as [[stock options]] among retail investors.
===== How Do Single-Stock Futures Work? =====
At its core, an SSF is a straightforward bet on the future direction of a stock's price, amplified by leverage. Understanding the mechanics is key to appreciating their power and their peril.
==== The Mechanics ====
Imagine you're interested in Awesome Inc. (ticker: AWE), which currently trades at $50 per share. You could buy a single-stock future on AWE. The contract would specify:
  * **Underlying Asset:** Awesome Inc. stock.
  * **Contract Size:** 100 shares. The total value of the contract is 100 x $50 = $5,000.
  * **Expiration Date:** A set date in the future, for example, the third Friday of December.
  * **Price:** The price is agreed upon today.
Instead of paying the full $5,000, you would only have to post an initial margin, perhaps 20% of the total value, which would be $1,000.
  * If you buy the contract, you have a [[long position]]. You are betting the price of AWE will rise above $50.
  * If you sell the contract, you have a [[short position]]. You are betting the price of AWE will fall below $50.
==== The Profit and Loss Equation ====
The magic and the menace of SSFs lie in how profit and loss are calculated. Because your position is worth $5,000 but you only put down $1,000, every dollar the stock moves is magnified 5x for you.
Let's say you took a long position and AWE stock rises to $55. The value of the shares in your contract is now $5,500. Your profit is $500 on a $1,000 investment—a 50% return! However, if the stock drops to $45, the value is now $4,500. You've lost $500, a 50% loss on your initial margin. If the stock continues to fall, you could lose more than your entire initial investment, and you would be required to add more money to your account to cover the losses (a dreaded [[margin call]]).
For the seller, the reverse is true. They profit if the price falls and lose if it rises. A seller's potential loss is theoretically unlimited, as there's no ceiling on how high a stock price can go.
===== Why Would an Investor Use SSFs? =====
Investors are drawn to SSFs for two primary, and very different, reasons: aggressive betting or conservative protection.
==== Speculation ====
This is the most common use. [[Speculation]] with SSFs involves making a highly leveraged bet on a stock's short-term price movement. Because of the low capital required, a trader can control a large number of shares to try and capture quick profits from small price changes. This is a high-risk, high-reward game that is closer to gambling than it is to investing. The leverage that creates spectacular gains can just as easily wipe out an entire account.
==== Hedging ====
[[Hedging]] is the more strategic use of SSFs. Imagine you own 1,000 shares of a company, and you believe in its long-term prospects, but you're worried about a potential short-term dip due to an upcoming earnings report. Instead of selling your shares (which could trigger capital gains taxes), you could sell 10 SSF contracts (10 contracts x 100 shares/contract = 1,000 shares).
  * **If the stock price falls,** the profit on your short SSF position will help offset the loss on your actual stock holdings.
  * **If the stock price rises,** the loss on your SSF position will be offset by the gain in your stock holdings.
In this way, SSFs can act as a form of insurance, locking in a price and reducing uncertainty over a specific period.
===== A Value Investor's Perspective =====
For followers of the value investing philosophy championed by legends like [[Benjamin Graham]] and [[Warren Buffett]], single-stock futures should be approached with extreme caution, if at all. Value investing is the art of buying wonderful businesses at fair prices and holding them for the long term, focusing on their [[intrinsic value]] rather than their daily price fluctuations.
SSFs are almost the polar opposite. They are:
  * **Short-Term Oriented:** Their very nature, with fixed expiration dates, encourages a focus on "what will the price be next month?" rather than "what will this business be worth in ten years?"
  * **Leveraged Instruments:** The use of leverage is a direct path to violating Buffett's "Rule No. 1: Never lose money." A small price movement in the wrong direction can lead to a permanent loss of capital, from which it is impossible to recover.
  * **Tools of Speculation:** For the most part, SSFs are used to bet on price, not to own a piece of a business. This is the definition of speculation, which Graham carefully distinguished from true investment.
While a sophisticated investor might theoretically use SSFs for a specific, calculated hedge, for the vast majority of ordinary investors, they are a distraction from the core task of finding great companies. They invite you to play a trader's game, a game that is notoriously difficult to win and fraught with risks that can permanently derail a sound, long-term investment strategy.