NATURE ABHORS A VACUUM, GOES the theory, and financial markets seem to follow identical laws, spawning a place to put every imaginable investment dollar. As dramatic ups and downs characterize financial markets' behavior these days, single stock futures (SSFs) have bubbled up as a way for opportunistic investors to play for tactical gains in a volatile environment. To meet this market, three Chicago exchanges (CBOE, CME, CBOT) partnered in late 2002 to create OneChicago, the nation's only SSF exchange. Among OneChicago's 120 SSF listings, one big builder—Lennar—joined the group in August (ticker symbol: LEN1C), and analysts suggest that more builders will appear among the SSF fold, but not in the near term.
So far, the jury's not in on how builders will perform compared with other industry sectors in the single futures market. Volume in Lennar futures has been light, while overall volume for SSFs combined was up 39 percent from January through November 2004 (over the same period in 2003), according to OneChicago's communications director Mary Haffenberg.
Hedge Your Bets “Ebay, Google, and Microsoft futures have drawn the most interest so far,” says Patrick Yon, senior market strategist for Lind-Waldock, a futures broker and division of Refco. None of his clients trade Lennar futures. They use SSFs to hedge their long positions in the stock market. If they guess a stock will decline, they sell an equivalent amount in futures contracts to lock in gains by picking up a dollar on the futures for every dollar they lose on underlying shares. More often, Yon says, they overhedge, selling perhaps $1.50 in futures contracts for every dollar they are long in the stock.
Yon also has clients who simply trade stock futures because there is more leverage than in the stock market. Margin can be as low as 20 percent on single stock futures whereas Reg T requires 50 percent margin on stock accounts. While stock margin is in the nature of an interest-bearing loan, futures margin is more like a deposit, although investors can still lose more than their original investment.
What does this mean for Lennar and other home builders that a single stock futures exchange might decide to list? (The decision to list an SSF is not in the company's hands.) Haffenberg has heard nothing to indicate that trading in Lennar futures has affected the home building industry or Lennar's stock. “To say we affect the industry would be inaccurate,” she says. Futures and share prices move in lockstep and do not give rise to arbitrage opportunities, she says. “The stock affects the futures price, not the other way around,” she says. Yon generally agrees with that statement, but says he believes that leverage in futures trading can contribute to volatility in the price of the underlying shares.
Haffenberg thinks investors will become more interested in SSFs as interest rates rise. Unless the contract is bought or sold back before expiration, the interest rate on SSF margin does not change, whereas stock margin is susceptible to interest rate hikes, she says. Prospects for additional home builders or index stock futures depends on demand, she says. Lennar got listed because people asked for it, she says, and there are no plans to add builders to the exchange at the moment.
The prospects for additional builder listings are good, Yon says, “but not anytime soon … maybe in two to five years,” he says. In his view, rising interest rates will delay this process because they will place downward pressure on builder shares and reduce interest in the industry among investors.
Commentators
Mary Haffenberg, Communications Director
OneChicago (futures exchange)
Patrick Yon, Senior Market Strategist
Lind-Waldock (futures broker), a division of Refco
