The end of single stock futures in the US

They were never given a fair chance

Jakub Rehor


June 22, 2021

The coronavirus pandemic finished off floor trading at venerable institutions like the CME, CBOE, and the LME. I wrote about this topic recently. There was another venue that quietly shut down last year. OneChicago, the US platform for trading single stock futures, closed its doors on September 18, 2020.

Single stock futures are a wonderful invention with plenty of benefits. Similar to regular commodity futures, SSF contracts are agreements to deliver the underlying stock at expiration date at a fixed price. Both sides of the trade (the buyer and the seller) put up margin as a good faith deposit guaranteeing performance of the contract. Neither side has to own the underlying stock.

Here is the first benefit of a single stock future. When an investor buys a stock on margin, he ends up paying interest to the broker. There is no margin interest payable on a future: there may even be interest income (if the margin is invested in Treasury bills). Right there we have substantial savings.

Second benefit: margin borrowing on stocks is limited to 50% of the stock’s market value. Futures require much lower margin (generally 5-10%, in case of single stock futures it’s set to 20%). Futures provide higher and cheaper leverage.

Third benefit: when an investor wants to sell stock short, he needs to locate and borrow the stock from a lender, paying a fee. The lender can demand return of the stock at any time. This can create problems: lenders can collude to force short-sellers to return the borrowed stock, leading them to scramble for any shares and driving up the stock price. This is the dreaded short squeeze and it is not a theoretical threat. We saw recently coordinated short squeezes in Gamestop and AMC shares organized on Reddit, with the specific goal to force hedge fund short-sellers out of business. With single stock futures, there is no danger of a short squeeze because nobody can demand early delivery of the underlying.

Investors who are looking to hedge their option exposure find single stock futures particularly attractive. The positions are easy to enter and exit, they require much less capital than hedging with the underlying stock, and single stock future expirations line up with option expirations so that combined positions can be closed or rolled over at the same time.

Single stock futures are quite popular outside of the US. They are actively traded in the UK, Germany, Switzerland, Spain, France, Italy, the Netherlands, Singapore, South Korea, Taiwan, Hong Kong, India, Russia, Mexico, Brazil, South Africa, Thailand, and Greece.

So why haven’t single stock futures caught on in the US? The answer is simple. The regulatory bureacracy in Washington killed them, for no good reason other than internal fighting over budgets and jurisdiction.

Before equity futures on the S&P 500 index launched in 1982, the SEC and the CFTC had a fight over who would regulate them. Were they securities, and thus under the purview of the SEC? Or were they commodity futures, and thus subject to CFTC regulation? Whoever ended up in charge would see growing importance and bigger budgets. The details of the political backstabbing and machinations were never revealed but the fight ended with a compromise. The so-called Shad-Johnson accord of 1982, reached by the heads of the SEC (Shad) and CFTC (Johnson) gave CFTC full jurisdiction over stock index futures while awarding the SEC full jurisdiction over stock index options. The accord also banned single stock futures in the US because, as Philip Johnson publicly admitted, “I was not willing to share regulatory jurisdiction with the SEC over these products.”

For twenty years, single stock futures were as illegal in the US as cocaine. Their decriminalization came about purely by chance. In the 1980s and 1990s, over-the-counter (OTC) derivatives trading grew from nothing to trillions of dollars, entirely unregulated. By late 1990s, the SEC and CFTC came to blows over who would get to regulate this new market. CFTC overplayed its hand in pushing to bring all OTC derivatives under its jurisdiction and suffered a humiliating defeat. The SEC not only got undivided power to regulate the swaps market but it also forced CFTC to accept shared jurisdiction over single stock futures. Thus the US single stock futures market was born, an unloved child of squabbling parents. In the words of former Chairman Johnson, “the CFTC/SEC regulatory regime is a harsh one, with margins, taxes, and transaction costs much higher than for other futures contracts and with severe restrictions on what stocks qualify.”

Let’s review the ways in which the SSF market was hobbled by regulators. Firstly, margins on SSFs were set at 20%, compared to 5-10% margins on index and commodity futures. Secondly, SSFs did not qualify for the same favorable tax treatment as other futures contracts: all profits were taxed at ordinary income rates. And finally and most importantly, brokers and advisors dealing in SSFs had to register with both CFTC and SEC and comply with both of their, often contradictory, requirements. The final point was the decisive one. Security broker-dealers looked at what it would take to dually register as FCMs (futures commissions merchants) and said no, thank you. Their retail customers were never given a chance to trade a single SSF contract.

It is no wonder that single stock futures didn’t live up to their potential in the US.

Is there a moral to this sordid tale? Yes, there is. We cannot rely on the regulators to act in the best interest of investors. Their pride and lust for power can trump any other considerations. If they need to murder an infant market in its cradle just so that the other agency across the street in Washington DC doesn’t get a bigger budget, so be it. Here is a dire warning to those voices in the financial community who call for more regulations: be careful what you wish for.