SINGLE STOCK FUTURESA TRADERS GUIDE

Patrick L. Young and Charles Sidey

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Single Stock Futures

WILEY TRADING SERIES

Single Stock Futures: A Traders GuidePatrick L. Young and Charles Sidey

Uncertainty and Expectation: Strategies for the Trading of RiskGerald Ashley

Bear Market Investing StrategiesHarry D. Schultz

The Psychology of Finance, revised editionLars Tvede

The Elliott Wave Principle: Key to Market BehaviorRobert R. Prechter

International Commodity TradingEphraim Clark, Jean-Baptiste Lesourd and Rene Thieblemont

Dynamic Technical AnalysisPhilippe Cahen

Encyclopedia of Chart PatternsThomas N. Bulkowski

Integrated Technical AnalysisIan Copsey

Financial Markets Tick by Tick: Insights in Financial Markets MicrostructurePierre Lequeux

Technical Market Indicators: Analysis and PerformanceRichard J. Bauer and Julie R. Dahlquist

Trading to Win: The Psychology of Mastering the MarketsAri Kiev

Pricing Convertible BondsKevin Connolly

At the Crest of the Tidal Wave: A Forecast for the Great Bear MarketRobert R. Prechter

SINGLE STOCK FUTURESA TRADERS GUIDE

Patrick L. Young and Charles Sidey

Published 2003 John Wiley & Sons Ltd, The Atrium, Southern Gate, Chichester,West Sussex PO19 8SQ, England

Telephone (44) 1243 779777Copyright # 2003 Patrick L. Young and Charles Sidey

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Library of Congress Cataloging-in-Publication Data

Young, Patrick L.Single stock futures : a traders guide / Patrick Young and Charles Sidey.p. cm.(Wiley trading series)

Includes bibliographical references and index.ISBN 0-470-85315-8 (alk. paper)1. Single stock futures. 2. Futures. I. Sidey, Charles. II. Title. III. Series.

HG6041.Y68 2003332.630228dc21 2003045068

British Library Cataloguing in Publication Data

A catalogue record for this book is available from the British Library

ISBN 0-470-85315-8

Project management by Originator, Gt Yarmouth, Norfolk (typeset in 10/12pt Times)Printed and bound in Great Britain by Antony Rowe, Chippenham, WiltshireThis book is printed on acid-free paper responsibly manufactured from sustainable forestryin which at least two trees are planted for each one used for paper production.

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Contents

Foreword ix

Acknowledgements xi

Introduction: Another New Product, Another Revolution xiii

Prologue: The Next Frontier xvii

1 A Simple Q&A 1

2 Basics of Single Stock Futures 9

3 Trading Single Stock Futures 39

4 Corporate Actions 59

5 Users of Single Stock Futures 81

6 Margin, Clearing, and Settlement 95

7 Single Stock Futures and Indices 113

Conclusion 125

Exchanges 131

Web acknowledgements 133

Bibliography 135

Index 137

To Iain Cain for being a great friend, the finest host on the CotedAzur and simply the best impromptu singer with which any latenight soiree can be blessed!

To Gaby for providing unstinting support and encouragement atall time, which I hope I can return in the future.

Foreword

Make No Small Plans

Daniel Burnham, famous late 19th century Chicago architect

It all started at Wiltons. A lot of things to do. Somewhere between the quaileggs and the bread pudding our conversation turned to the challenge that wasfacing my friend.

It was 1997 and Sir Brian Williamson had just agreed to become Chairmanof Liffethe embattled derivatives exchange that was fighting for survival. Itsdemise would be a significant chink in Londons armor and threaten the cityspreeminence as a financial center. The first step was clear: close the floor andmigrate all trading to an electronic platform. Easily said, but never beforesuccessfully accomplished on this scale. The second step was equally challeng-ing. Invent a product complex that had the potential to be as significant as theinterest rate complex.

As a student of markets the path was obvious. Equity derivatives had a longhistory. Futures and options on single stocks had been traded in Amsterdam inthe 17th century. Their natural evolution demonstrated their importance asa risk-shifting mechanism. For a variety of institutional and legal reasonsthey were dormant for centuries. Modern equity derivatives began in 1973 atthe Chicago Board Options Exchange and had been successfully imitatedworldwide. This was followed by the invention of stock index futures at theKansas City Board of Trade. These were successfully innovated at the ChicagoMercantile Exchange and ultimately imitated worldwide. The missing piece ofthe puzzle was a futures market on single stocks. I had unsuccessfully tried tofill this gap in 1982 at the Chicago Board of Trade with the design of narrowly-based indices, which in some industries were surrogates for single stocks. This

led to the ShadJohnson accord between the SEC1 and CFTC,2 which bannednarrowly-based indices. The legal ban on single stock futures and surrogatesstill left the complex incomplete.

While the elimination of the ban in the United States seemed daunting theprospects in London seemed better, particularly if it was championed by theright individual. It required the vision of a divergent or outsider mentalitycoupled with competencies of a convergent or insider mentality. Sir Brianhad these qualities. Ultimately the stamp tax on futures disappeared and theBank of England and the Securities and Futures Authority recognized therationality of the concept. The timing was also right. Debt was a 1980scommodity and equity a 1990s commodity. The U.S. financial sectorprovided the paradigm. In 1990, there was $2 trillion in the form of Federaldebt in the U.S. Ten years later that figure had risen to $3 trillion, while duringthe same period the size of the U.S. equity market rose from $3 to $14 trillion.Europe was having a similar transformation.

By the time the armagnac and cigars arrived the path seemed clear. One lastquestion remained. How would this resonate in the United States? Liffe wouldlist both U.S. and European stocks. This would inevitably result in politicalpressures to lift the U.S. ban. We thought that would ultimately broaden theinterest in the markets and become a catalyst for a self-fulfilling prophecy.Several years later LIFFE launched Universal Stock Futures. It was success-fully imitated in continental Europe. The ban in the United States was liftedand OneChicago and NQLX3 launched single stock futures in N.Y. andChicago in 2002. Liffe had a record volume that very same year. A lot hadhappened in a short five years.

It was a wonderful dinner with a dear friend.

Richard SandorChicago, January, 2003

x Foreword

1 SECSecurities & Exchange Commission, the US regulator for equity trading.2 CFTCCommodities Futures Trading Commission, the US commodities and futures

regulator.3 NQLXoriginally standing for NASDAQ LIFFE markets, NASDAQ withdrew in

mid-2003, leaving Euronext LIFFE in sole control. NQLX along with OneChicago are

the two principal US single stock futures exchanges.

Acknowledgements

To list everybody who has provided input on Single Stock Futures: A TradersGuide is a tricky issue but as ever well try . . . on the premise that all omissionsare ours and we sincerely appreciate everybody who has helped us to create thistome: James Barr, Max Butti, Caterina Caramaschi, Caroline Denton, JamesDunseath, John Foyle, Hugh Freedburg, Juliette Proudlove, Simon Raybould,Sir Brian Williamson, Denise and Geoff at Euronext LIFFE reception/switch-board (who always thought we wouldnt mention themas if !!!), Nick CarewHunt, Sonny Schneider, Jonathan Seymour, Luis Velasco, David Lascelles atCSFI whose report The Ultimate Derivative we can wholeheartedlyrecommend, Richard Sandor, NQLX: Bob Fitzsimmons, OneChicago: BobPaul. Also to Mike Charlton, Steve Smith, Carlo