Exchanges Are Pushing for Single-Stock Futures Plan

The U.S. government's ban on trading single-stock futures in the U.S. was supposed to be a temporary one. It has now been in place since the early 1980s.

But a U.S. futures industry concerned with competition from international and domestic rivals is pushing the government to lift the ban, which was part of the so-called Shad-Johnson Accord between the Securities and Exchange Commission and the Commodity Futures Trading Commission. Legislation is being drafted in Congress that would lift the ban on single-stock futures and sector-based index futures contracts, says John Damgard, president of the Futures Industry Association.

While futures seem too risky and esoteric for most individuals, investors could use the single-stock futures contracts the same way they use listed options -- to hedge existing positions or to speculate on future movement.

U.S. markets, such as the Chicago Board of Trade and Chicago Mercantile Exchange, are worried that European markets, which already trade single-stock futures, will build an insurmountable lead in trading the products. Bret Gallaway, a spokesman for the CBOT, notes that foreign exchanges can trade futures on IBM (IBM) and other U.S.-based companies, but U.S. investors are prohibited from trading them.

Stock and options exchanges will see more competition if retail investors migrate to futures contracts instead of trading the underlying stocks or options. In the past, futures exchange officials (such as CBOT Chairman David Brennan) have said stock and options exchanges oppose single-stock futures because they fear competition.

Stock and options exchanges have, of course, a different take on the subject. "We're not afraid of the competition," says Dale Carlson, vice president of corporate affairs at the Pacific Exchange, which trades both stocks and options. The other options exchanges should be equally accustomed to the rigors of competition, especially after being subjected to battling for order flow on almost every major listing for the past nine months.

If You Build It ...

Beyond regulation, though, there is still a question of whether investors will trade stock futures. The General Accounting Office report published this month states that volume on single-stock futures contracts in foreign markets "has been relatively low." The GAO report (citing data supplied by the CBOT and the FIA) says nine foreign exchanges trade single-stock futures in more than 189 stocks. In 1998, volume in foreign single-stock futures totaled about 2.1 million contracts, the report said, less than 1% of the total trading volume of the foreign futures market.

That's not much volume, and it wouldn't translate into much revenue generation for U.S. futures exchanges either.

Officials from the OM Stockholm Exchange told the GAO that the low volume in single-stock futures was a result of exchange members' weak retail marketing efforts. They believe this is partly because it would take away from stock-trading revenue and because professional investors seek less-expensive hedging instruments.

"For example, the exchange officials said that options market makers typically use the more liquid cash market to hedge their risk," the GAO report said.

U.S. markets are eager to test the waters. According to the GAO report, officials with the Chicago Mercantile Exchange say if the ban on single-stock futures is repealed, it will be interested in pitching it to retail investors. Also, FIA head Damgard says that single-stock futures may have a lot of commercial appeal.

Trading them wouldn't be too difficult for investors. Futures exchanges say they'd be willing to set margin levels comparable to those set for people who sell stock options, according to the GAO report published this month on the Shad-Johnson Accord. For stock option sellers, margin "is currently set by exchange rules at the current market value of the option (the premium) plus 20 percent of the current market value of the underlying stock (i.e., 100 shares per option contract), minus the amount (if any) that the option is out of the money," the GAO report says.

Either way, the futures industry wants to get the governmental and regulatory hurdles out of the way as soon as it can. The SEC and the CFTC have reached a tentative deal, whereby they will jointly regulate single-stock futures.

Overall, Damgard says the marketplace -- not "some bureaucrat in government" -- should decide whether there is actually demand for the product.

>To order reprints of this article, click here: Reprints