Single stock futures are a relatively new product, and are yet not widely known, but they should be. They are an excellent investing tool. So what are they?

Single stock futures are similar to the more familiar futures contracts on indices like the S&P500 or the Dow. They trade on the the OneChicago Exchange. Like stock options, they are sold in units called “contracts,” each of which controls 100 shares. They also have a strike price, and an expiration date. Unlike an option, though, a futures contract creates both the right and the obligation to buy or sell the stock at the strike price on the expiration date.

A Near Perfect Hedge

The effect of this is that single stock futures contracts track the performance of the underlying stocks almost exactly, with a couple of caveats. Specifically, for a long position, the price of a single stock futures contract is generally equal to the current stock price, discounted for any dividends that are scheduled to occur prior to the expiration date, plus interest according to prevailing rates. Similarly, for a short position, the price is the current stock price, plus any dividends to be paid, less interest.

Like options, pricing of futures contracts varies according to supply and demand. Plus, unexpected changes in dividend payments can cause the performance of a futures contract to vary from the underlying to a certain extent. Thus, these contracts will always be a near-perfect, but not 100% perfect hedge. Still, they track their underlying stocks so closely in general that they are excellent hedging devices.

Putting Stock Futures to Use

So, how can you put single stock futures to use? Firstly, single stock futures generally require only 20% of the value of the underlying to be put up as margin. Thus they are an easy way to create leveraged positions.

Never Sell Short Again

More importantly, if you like to sell stocks short, you may want to consider selling a futures contract, instead. Why is this? Because selling short has a number of disadvantages. You must wait for an uptick in the price before you can enter the position. Then you must borrow the stock. If there’s no stock available to borrow, you’re out of luck. On top of all that, you might be exposed to hefty margin interest if the position moves against you and you don’t have sufficient excess cash in your account to cover the loss.

Selling a single stock future eliminates all of these problems. There is no need to wait for an uptick or borrow the stock. And instead of having to pay margin interest, you collect interest on the position. Lastly, only 20% of the price is tied up in margin. You can invest the other 80% in a safe income instrument and collect even more interest.

Cheating the Tax Man (Legally)

Futures can also be helpful for tax management. Say you hold an appreciated position in a stock which you would like to sell, but you don’t want to pay short-term capital gains taxes. (Who does?). You can instead sell a single stock future contract for the stock and lock in your return. You can then wait until the long-term capital gain cutoff, collecting market interest on the size of the position in the meantime. Once the minimum holding period has passed, you liquidate both positions, and collect your short-term profits while paying long-term capital gains tax.

Stock futures have many other uses for creative investors. You can learn more at the OneChicago website.

Not many brokerages offer stock futures at present. If your broker doesn’t offer them, put in a request that they add the feature. Stock futures are a flexible tool with a wide variety of applications. They belong in your investing arsenal.