Topics for May
Copyright (c) 2001 Commodity Systems Inc. (CSI). All rights are reserved.
Topics discussed in this month's journal.
CSI will be
closed for voice communication on Monday, May 28th for the Memorial Day
holiday. U.S. exchanges will be closed, but data from other exchanges will be
available at the normal posting times. The CSI host computer will be accessible
throughout the holiday weekend.
The term "single stock futures" may sound like an oxymoron, but it perfectly describes a new investment vehicle that could be the wave of the future. A stock future is not unlike any other future contract -- it is a contract to buy or sell shares of a particular company at a predetermined price and date. Exchanges are touting stock futures as simple, efficient tools that allow the investor to gain exposure to stock price movement without the costs of owning the securities themselves. Opponents are cautioning that these new futures contracts make it easier for investors to take on potentially crippling risks.
Last month we showed how stock trading was an unbalanced medium in which nearly all investors win or nearly all investors lose. The new single stock futures alter that norm, making it into a zero-sum game where buyers are equally balanced with sellers. As with the traditional futures markets, for every count in open interest there is one winner and one loser, each with precisely matched gains and losses.
Stock futures facilitate the taking of large positions in several ways. First, the up-front costs are relatively low. Margin on a stock future contract would be much less than the cost of buying the stock outright. Given that single stock futures are like commodity futures, a margin sufficient to protect the broker against an overnight loss can be as low as 5% on some exchanges. Margin requirements for stock futures are related to volatility and can be higher, however; sometimes significantly so. Whatever the margin expense, there would be no borrowing cost (interest) for the remaining percentage of the contract value because the delivery date would be in the future. These numbers contrast very favorably with those for the trader of stock shares, who must put up a 50% deposit, and who is then obliged to borrow the remaining 50% at prevailing interest rates. A major purported advantage of stock futures is the ease at which positions can be taken. While one cannot easily sell a stock short on the open market, participating exchanges can now routinely handle short stock futures contracts.
Single Stock Futures (SSFs) are established, though not hugely popular, investment vehicles in Sweden, Finland, Portugal, South Africa, Hungary and Australia. SSFs began trading in January of this year at additional exchanges, including the London International Financial Futures Exchange (LIFFE), Euronext (formed from the Amsterdam, Brussels, and Paris stock exchanges), the Spanish Futures and Options Exchange (MEFF) and the Bourse de Montreal exchange. U.S. exchanges were prohibited from joining the wave because regulations (the 1982 Shad-Johnson agreement) banned the trading of stock futures. In the late 1990's, some U.S. futures firms, legislators and regulators began complaining that U.S. laws placed U.S. investors at an unfair disadvantage. They argued that the ban on futures trading should be lifted in light of the anticipated increase in international access to stock futures, including some futures on U.S. equities.
Although the Shad-Johnson agreement initially created the CFTC, its overhaul was endorsed by CFTC Chairman William Rainer, SEC Chairman Arthur Levitt and Federal Reserve Chairman Alan Greenspan, and urged by Senator Lugar of Indiana. The Commodity Futures Modernization Act, which was signed into law at the end of the Clinton Administration, effectively cured the "unfair competition" claim voiced by opponents of the Shad-Johnson agreement. The new U.S. regulations called for a one-year waiting period from the date of enactment before stock futures could be traded, so an August, 2001 start is planned for principal-to-principal single stock futures trading, with access for individual traders to begin on December 21st of this year.
The CFTC and the SEC have joined forces to provide for efficient execution and clearing of single stock futures in the U.S. We do not yet know exactly how the contracts will be arranged, but we would expect something similar to what we currently have for options, and similar to the model already in place in other countries.
For example, London's LIFFE exchange, which began trading "Universal Stock Futures" at the end of January, currently offers them for 40 securities, representing companies based in the U.S., UK, Finland, France, Germany, Spain, Italy, and the Netherlands. LIFFE trades the two forward quarterly contracts (currently June, 2001 and September, 2001) and the nearest two serial months. Contracts are typically in 100-share lots for the U.S. and continental European markets and 1,000-share lots for U.K. markets. Trades on LIFFE are done in units of each stock's local currency, so that U.S. stock futures are traded in dollars, UK stock futures in British Pounds, and continental European stock futures are traded in Euros. Volume for all delivery months on April 11th for the 40 LIFFE SSFs was 7,870, an average of about 200 contracts per stock.
It is anticipated that competition among U.S. exchanges, most of which have entered into international alliances, will spur greater volume in SSFs when they begin trading here. Many details are yet to be worked out, and many new regulations need to be understood. Potential traders of single stock futures are urged to learn as much as possible about this investment vehicle, including its inherent and considerable risks, before investing.
At CSI, we are seeking credible sources of overseas SSF data and hope to quickly add summary trading details to our database. Without passing judgment on viability or suitability as an investment tool, we are also preparing for the commencement of single stock futures trading in U.S. markets. We plan to include pricing in our data feed from inception. We are excited about the prospect of supplying single stock futures data, which is a natural for CSI's business model. Please watch for details as this new investment vehicle emerges.
We are pleased to announce that we have engaged several new commercial sources of exchange data, adding additional redundancy to our service. Our objectives in nearly doubling data input were to further enhance our accuracy record and to expedite the time that data is released.
Our multi-layered screening process often reveals discrepancies between quote providers, and these discrepancies alert our staff to investigate and post only the correct values. Factors such as format or procedural changes, dividend rules adjustments, local weather conditions for satellite receipt and remote site personnel changes seem to affect some of our data sources on a regular basis. The ability to compare input from multiple origins greatly reduces the chance that our output will be flawed. With five independent data sources, CSI has the necessary resources to assure the cleanest database in the industry -- day in and day out. Each service we employ has similar exchange sources, but what goes on between their ticker plant and the eventual release to the ultimate customer is what makes the difference.