Single Stock Futures allow a futures trader the added benefit of increased diversification by venturing into the world of equity products, along with enhanced leverage (20% margin requirement versus 50% in equities)

Likely Uses Of SSFs
SSFs are likely to find uses in trading stocks that are hard to borrow, in index deletion and enhancement strategies, in alpha management, in the creation of synthetic cash, and in matched pairs and market neutral trading strategies. It is fair to say that these instruments are not for everyone but that those who understand then will find the market quite useful.

What Are Single Stock Futures?
Many of the characteristics discussed below are common to all competing exchanges that will offer SSFs. A SSF, quite simply, is an obligation to make or take delivery of 100 shares of the underlying stock three business days after the third Friday in the expiration month. This is consistent in delivery methodology, timing and size with the established equity options markets, and that is by design. The model of underlying/option/future has worked quite well in non-equity markets and in the equity index market.

The Options Clearing Corporation (OCC) will be the clearinghouse for SSFs, and will handle the very important adjustments to price that will derive from corporate actions such as splits, special dividends and mergers. The various trading halts and other special considerations that affect the primary stock market will affect the SSF market on an equal-as-can-be basis.

For the NQLX market, which has published preliminary contract specifications, five calendar quarters and two serial months will be offered so that the first three calendar months always will have a futures contract. The issues selected for inclusion are based on an algorithm that includes volatility, liquidity, trading volume, and the degree of risk unhedgeable by broad-based index futures. While this algorithm was created with active traders in mind, another class of users, custodial banks with large amounts of stock available for lending, may be served best by including less-active shares in the mix. New issues can be listed on the next business day.

The hybrid nature of SSFs has created some interesting issues. The instruments can be held in either a stock account or in a futures account. Both Series 3 and Series 7 brokers are "grandfathered" to sell them and will have to take a continuing education course; new entrants into both sides of the business will have SSF questions on their licensing exams. SSFs will be taxed on a short-term capital gains basis, not only the 60% long-term / 40% short-term capitals gains blend common in futures; open equity on December 31 will be taxed, as is the practice in futures. It does not appear that a sale of a SSF against a long equity position will constitute a constructive sale of the stock unless the stock is delivered against the short future. Should this be the case, the sale price of the stock is the price at which the future was sold. This treatment facilitates SSFs as hedging instruments. Final taxation rules have yet to be resolved.

Also unresolved at the time of this writing, some key issues in margining have not been resolved by the two regulatory bodies in charge, the SEC and CFTC. These include the use of open trade equity, which may earn interest in the futures world but not in the equity world, and whether a move toward risk based margining systems such as SPAN will be allowed to proceed. At present, SSFs are to be given the strategy based margin preferences common in the equity option world. Another issue is the treatment of margin calls; the futures industry practice is for next-day settlement, while the stock world operates on third-day settlement. The Commodity Futures Modernization Act of 2000 stipulated that margin levels for SSFs could be comparable to those for equity options, or 20% of the value of the underlying stock. For some stocks, this level is higher than justified, and for some stocks the Regulation T level of 50% may be too low.

SINGLE STOCK FUTURES AND THEIR ROLES IN EQUITY MARKET
Markets can achieve only a limited number of objectives. The first and foremost of these is price discovery, the collective assessment of what any underlying asset is worth at any given point in time. While some derivative markets, such as Treasury and natural gas futures, have assumed the role of primary price discovery venue, no one is forecasting that SSFs with overtake the cash equity markets in this critical function.

A second role of markets is the disconnection of price from the underlying physical transfer. This is quite common in most physical markets wherein both buyer and seller pay and receive exchange-of-future-for physical contracts, remain floating on their price, and then fix their prices independently of each other. Here again, SSFs are unlikely to move into a significant role: While both buyer and seller for, say, corn can agree they need each other to remain in business, no similar interdependencies exist in the equity world once the underwriting is complete. No one needs to buy and sell stocks except at a price they find compelling.

A third role of markets holds far greater promise for SSFs, and that is risk management. Prior to the introduction of equity derivatives options in the 1970s, index futures in the 1980s shareholders had only one way of protecting their portfolios during market downturns, and that was to sell. This created a classic negative sum game wherein each participant, by trying to maximize his individual welfare, unwittingly minimizes the welfare of the group as a whole. It is no accident that there have been fewer market panics and crashes over the past quarter-century than there were during, say, the 1920s. The U.S. stock market and economy had regular panics and crashes throughout the 19th and early 20th centuries: 1819, 1837, 1857, 1874, 1894, 1907, and 1929. The addition of derivatives ended that cycle, and for that we should all be glad.

All markets provide the social benefits noted above once allowed they are allowed to operate. For all of their acceptance and for the vast role they play in both our nation's economy and daytime television industry, equities are a remarkably incomplete market due to various asymmetries in their structure. Chief among these is the high cost involved in taking a short position in the market. At present, short sales of stock involve locating the shares to borrow, borrowing the shares and paying the broker loan rate of interest. Another impediment, likely to fall once the SSF market moves into high gear, is the "uptick" rule imposed during the 1930s that precludes a short sale within a declining market. Futures markets are free from these asymmetries and therefore should be more efficient and complete.