Single Stock Futures: What They Are, How to Use

Futures contracts were originally agreements to buy or sell an asset at a predetermined price at a specified time. They are considered "derivatives" because their value is derived from an underlying asset. Early futures were tied to primarily physical commodities, such as agricultural products and precious metals. Over time, trading in index futures became some of the most popular futures contracts.

Like index futures, single stock futures will be cash-settled, also known as financially settled. That means there is no delivery of physical shares at expiration. Instead, any gains or losses are credited to or debited from traders' accounts.

Additional details of standard contracts:

• Tick size: This is the standard contract's minimum price move up or down. Because SSFs are derived from individual stocks, their tick size is $0.01—the same as the underlying stocks.
• Contract multiplier: The multiplier is determined by the contract size and is set by the CME Group. Standard SSFs have a contract multiplier of 100, meaning each contract represents 100 shares of the underlying company's stock.
• Margin: Futures contracts enable traders to take positions with lower initial margin requirements than stocks. That means traders can gain exposure to larger positions with less initial capital. This also means that small moves in the underlying asset can lead to outsized gains or losses.
• Dividends and corporate actions: Ordinary dividends are already reflected in futures price, eliminating both early exercise risk and any obligation short traders might have to pay dividends. Corporate actions such as splits, reverse splits, and special dividends may trigger adjustments to keep the SSF contracts aligned with the underlying security.

Single stock futures enable a trader to potentially capitalize on a downward move in the price of the underlying security. Unlike with short selling equities, there's no uptick rule to navigate when creating a short futures position. Also, it doesn't require borrowing shares or involve borrowing costs. Short futures positions, however, do still carry unlimited risk.

A trader holding a long stock position could potentially short the corresponding single stock futures in an attempt to hedge against a decline in the stock's price. However, it's important to consult a tax professional before using this strategy because it may come with tax implications.

This strategy also comes with additional risks, as the futures price won't necessarily track the stock price 1:1. Creating a short position with a SSF contract limits upside gains from the long stock position, and any expiration and rollover of the futures contract would involve additional transaction costs and possible price slippage.

Keep in mind that all uncovered short positions create unlimited risk as there is no limit to how high the price of the shorted position may go; in other words, if an investor must buy-to-close that position, there is no limit to how much they may have to spend to close the short position.

Speculative traders may use futures contracts to target directional movement in the underlying equity's price without owning the actual shares. If the trade moves in their favor, they can potentially accrue large returns relative to the margin required up front—but can also suffer substantially magnified losses with small price movements, and losses can even exceed the initial investments.

Because SSFs focus on the price action of a single security, they can be used to build pair trades, such as going long one SSF and shorting another in the same sector. This strategy enables a trader to speculate on relative performance between the underlying securities.

Single stock futures come with risks and trade-offs:

• No shareholder privileges. Futures traders don't enjoy voting rights or other benefits that come with owning equity shares outright.
• Active monitoring. Given the nearly round-the-clock trading hours, futures positions require closer attention and may not be a good fit for buy-and-hold investors.
• Liquidity. Trading volume in SSFs may likely be thinner than that in the underlying shares, which could mean wider bid/ask spreads and less favorable pricing—particularly soon after the product launches.
• Tax considerations. As mentioned above, traders who own a long stock position and short the same security via an SSF may face unique tax challenges and should discuss the strategy with a tax professional.
• Leverage cuts both ways. Just as smaller cash upfront can amplify gains, it can also mean bigger losses beyond the initial margin.