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April 21, 2005

Don't Forget Margin and the Risk

By Mark Longo

Single stock futures are similar to U.S. equity options because each contract is for 100 shares of the underlying stock. However, instead of paying different prices depending on strikes and volatility, futures require only an initial margin payment. In the case of single stock futures, the margin requirement is 20 percent of the value of the underlying position.

For example, let's say that you want to buy 10,000 shares of XYZ stock at $80 per share. Normally, this would require you to finance an $800,000 equity position and incur hefty interest rate risk. However, with single stock futures, you are only required to make an initial margin payment of $160,000. This single margin payment eliminates the interest rate risk and opportunity cost of financing the entire equity position. In addition, institutional traders can use securities such as T-bills or stocks for their margin payments, opening up a wide range of position swapping possibilities.

As with all products, there is a per-contract fee that varies depending on your membership status and trading volume. The above example would require the purchase of 100 futures contracts at anywhere from $.15 to $.30 per contract. However, One Chicago is currently implementing a flat monthly fee program on a trial basis. There is a potential downside. Anyone who is considering using futures products should remember that futures are marked to market. This means that, unlike stocks or options, there are no paper losses in futures. Your initial margin payment is credited or debited at the close of each trading day. If your balance falls below the maintenance threshold, you will be required to deposit additional funds.