Single Stock Futures: Leverage, 24/7 Access, and the Risks Retail Traders Can’t Ignore

Summary

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Mary MacNamara  

Hello, everybody, and welcome to Cents of Security. Today, we are discussing single stock futures with Ryan Gorman, who is the Manager of Retail Education at the CME Group. So, Ryan, welcome back. How are you?

Ryan Gorman  

I’m doing really good, Mary. Thanks again for bringing me on. It should be interesting

Mary MacNamara  

What exactly are single stock futures?

Ryan Gorman  

Right off the bat, the biggest difference is what we tried to offer is be able to give individual traders the opportunity to trade individual name stocks with leverage. And so basically what you’re doing if you’re trading a single stock future is you’re trading an individual stock name, and then you’re using the power of futures that come with that.

So, think of all the benefits of futures. One would be 24-hour trading. All these different things, the l- inherent leverage you get with a futures contract the fact that there are these expirations on the contract. These are all some of the things that kind of differentiate from owning the actual stock.

I think everybody understands if you buy a stock, if you buy a share, you’re buying essentially ownership in a firm. And, even if it’s one share, technically you’re buying ownership in it. With single stock futures, they are treated as a futures contract, so it is just a futures contract itself, so there’s no, deliverable asset of shares when it comes to expiration.

So basically, what we’re doing is we’re offering traders the ability to get leverage on individual names without having to go to the options market, which right now is a lot of the times what a lot of retail and individual traders are doing, looking at maybe shorter-term options to get some leverage.

Mary MacNamara  

Why would an investor choose to trade single stock futures instead of owning the stock outright? What’s the appeal there?

Ryan Gorman  

Yeah, 100%, and it’s fair. One thing right away is the inherent leverage that comes with it. And again, a leverage can be a great thing and it can be a terrible thing. It works both ways. So as great it is on the way up, it can be just as bad on the way down. But a lot of traders are looking for leverage.

They’re looking to be able to get that leverage from an individual name, which hasn’t really been available. So that’s the main difference. And then a lot of the thing that comes with it too is the expiration. If you’re trading, in a stock name, if you’re trading options on equities, a lot of the times if you have these, options or equities, you’re owning that.

So, you actually own that asset then at the expiration of the option, if it’s in the money or, you’re just outright buying and selling shares. This way you’re not doing that. There are no rights of ownership involved, so you can get that leverage there. Another thing too is a lot of the retail traders that, we talk to, we speak to a lot, they’re working full-time jobs.

So they might not be able to sit at their computer from, Chicago time about 8:30 am to 3:00 pm or 4:00 pm and look at the market and trade individual stock names and, but they’re up at 6:00 am looking at their portfolio and they’re at their desk at eight o’clock at night just looking at individual stock names, watching the news, and this kind of gives you the ability to go and do it.

Now, I’m not encouraging anybody to stay up all night and trade these futures contracts all night, but you have the ability to do whether you want to use it as some sort of a speculative tool completely, use it against a long-term stock portfolio, whatever you really want to do is totally fine, but we’re giving traders the ability to do the ability to choose to do that.

Mary MacNamara  

How does leverage work in a single stock future, and why can that be both an advantage and a risk for beginners?

Ryan Gorman  

Yeah, it’s a fair question. Again, when you think about leverage, a lot of times people’s heads always, they get frightened immediately, and that’s not necessarily a bad thing. You should be- understand the risks that come with it. But essentially, instead of just buying like a share of a stock, say a stock’s at $100, you put $100 into a stock.

If that stock goes to zero, you’re out $100. It’s pretty simple. But, with a futures contract, it doesn’t work like that. The single stock futures contracts are quoted in 100 shares, so essentially you are getting significant leverage on these individual stock names. The same way any futures contracts work with a simple multiplier that they all have, the single stock futures have it of 100.

So really that’s the biggest thing. You have to understand what that means for your P&L and there is a little bit of a learning curve involved if you’re coming just from equities over to futures and, I always concede it’s just something you have to learn. With single stock futures, they’re all 100, so that’s a little bit of an advantage outside of just every other futures contract, because they all have different multipliers that you really have to learn.

But it’s important to understand how that can be great because, like I mentioned a bit earlier, if it’s going in your favor, it’s excellent, and when it’s not, it can go really quickly. So that’s where risk management techniques that you’ve learned, trading equities, trading other futures contracts, they’re going to apply directly over to these single stock futures, and it’s going to be most likely the most important part of your trade strategy

Mary MacNamara  

So, what’s the biggest misconception about single stock futures that you see all the time?

Ryan Gorman  

Yeah, probably the number one question I’ve gotten we’ve been going around and talking to a lot of traders about it. The number one question I get is how do they settle? Because when you think about, like I mentioned earlier, a lot of traders use short-term equity options or just equity options in general in order to get exposure to individual names with leverage.

It’s a very common way to do and, depending on how that option goes, that can settle, it can either go out worthless, or it’ll settle into shares of the actual stock. So, I keep getting the question, how do single stock futures settle? Do they settle in shares, or how does that work? And the answer is they settle financially, so they settle into cash.

That in and of itself is something that, can be very beneficial for some traders, and we’ve gotten, a lot of thumbs up from people saying, “That is excellent. That’s great to know.” So that’s probably the biggest one. Outside of that, people are just curious about what that leverage actually is.

And having that baseline metric unit of 100 shares pretty much has cleared it up. But essentially, that big high arching thing I tell people, it’s you can trade individual names with leverage without having to worry about optionality. And within optionality comes time decay, theta decay, and it’s something that you have to worry about if you’re trading, some of those 0 DTE, 3 DTE options that now you don’t have to worry about

Mary MacNamara  

So how are single stock futures typically used? Are they used more for speculation, hedging, or something else, or a little bit of both?

Ryan Gorman  

Yeah I think the answer’s going to be a little bit of both. For the hedging perspective, you can think of it as, you have your retirement account that’s basically, your long stocks. You have a lot of stocks that you’re long, and you’re not really trading that account.

That account is, maybe you’re sending money in there every week, every two weeks, every month, and you’re just looking for that to grow over time. But, say there’s potentially an earnings report or a big report coming out for an individual stock that you’re invested in, you can go to single stock futures, and you can layer in an opinion, layer in a bias on that market.

If it’s earnings, that potentially could be outside of traditional market hours, so you can put on a position there. If you are worried about an overnight move, you can put on a position overnight. But then there’s the whole just speculation piece where there’s a lot of traders out there that just simply want to buy and sell stocks throughout the day, or just whenever they have time to do it, and they like that they can get that inherent leverage.

For people that are trading in and out and are not necessarily holding positions overnight or anything like that, getting that intraday leverage, while maintaining that good risk management skill can be very powerful for a lot of traders that are looking at these products.

Mary MacNamara  

What happens behind the scenes when a trade goes against you in a futures position? How do margin and risk come into play?

Ryan Gorman  

Yeah. This is the leverage we’ve, kind of hinted at. Basically, what happens is, when you think about a stock going against you, where margin comes in is, if you have a stock account, just a cash account, for example, just make it simple. I use the example of $100.

Say you buy a stock for $100, and it goes down to 50, your balance is down to 50, and then if it goes to zero, you’re out and you’re done. With futures, you can lose more than you initially invest. So, if you put $100 into something, you can lose significantly more than that. On the upside, you can gain significantly more than that.

But margin is the name of the game here, and it’s one of those things where, you know, when you’re looking into any new product, it’s super important to really understand the risks and how these work. If you think about that 100-share unit, that’s going to be a good starting point.

And then also understanding, “Hey, what is my margin? What is my initial margin I need to put on a position? What margin do I need to maintain this product overnight if I’m going to be holding this position overnight? And is my capital in a spot reflecting that I can do either of those?” So, it’s probably understanding the product that there is leverage, and then understanding how, say a 5% move would affect you, how an 8% move in either direction would help you.

And you can do all of this, throughout the day, throughout the week, if you’re doing preparation maybe on Sunday night. It’s really important to understand, “Hey, how much am I actually willing to risk on a position knowing that there’s inherent leverage?” And it may change, if you’re just a stock trader, it might change your investment strategy a little bit just because, 10% down on a stock can be very different than 10% down on a futures contract just because of that leverage.

So, understanding, “Hey, what’s my initial margin? What’s my balance? And what do I need to hold this overnight if I’m going to do that?” is probably step two. Once you decide, “Hey, I’m interested in this product,” then you go and understand the product specifications and what do I need to do to maintain this contract and protect myself in case the worst thing happens, which is probably the third thing you should ask yourself when you look at these markets.

Mary MacNamara  

Good answer. All right. If I’m just starting out and don’t have a lot of capital, are single stock futures a smart way to get more exposure or possibly a fast way to lose money, in your opinion?

Ryan Gorman  

In my opinion, it depends on your level of experience. If you’re somebody that’s been trading for a long time, maybe equities, maybe options, and you understand leverage, and you understand, margin and how it works, and you understand the product, and what you’re looking for is leverage on individual names, I think it’s great.

I think it gives you an opportunity to do especially if you’re somebody, doctor, lawyer, coach, anything, someone with a full-time job that, just can’t trade from 8:30 to 3:00, and you want to be able to get leverage on these names, I think it’s a really great place. Now, if you’re somebody that’s brand new to trading and you have, lower capital to start with, that’s where all the education comes in.

I’m biased being on the education team here at CME, but, there’s tons of things on Interactive’s website, through CME as well, where you can go and really learn the basics of futures first. Even though these are stock names that are very familiar to you, they act very differently, a- as we’ve talked about throughout, this entire show.

They act differently. They have different characteristics. So, what we don’t want is people to jump into a product they don’t understand and have things go against you, and then you never trade again. I’d rather you take a little bit more time, really understand the product, do your research, figure out what individual names within single stock futures you like, you have an interest in you like doing research on, and then I would just start slow.

Maybe start with a little bit tighter stops, a tight stop and then a tight limit a little bit higher, just to really understand the price movements but I think they can be beneficial for everybody. If it’s something that you understand the risks of and you can go in and say, “I’m comfortable with what I’m doing, and I’m going to utilize this to get some leverage on individual names,” I think it’s a win for those people

Mary MacNamara  

Really, this is great information, Ryan. Really appreciate your feedback and also your insights. Just want to remind everybody that you can go to the CME website, look under their education, and also Interactive Brokers. We have Introduction to Futures, as well as we have a whole, I think there’s 10 or 15 different CME courses that you can take on the campus website, Interactive Brokers Traders Academy.

So, Ryan, thank you so much. And beginning of summer, right?

Ryan Gorman  

Yeah, the weather’s turning. It’s getting hot. I, I love it, and I kinda hate it a little bit this time change it screws things up a little bit, but I’m excited definitely

Mary MacNamara  

Yep, yep. It’s nice to be in Chicago, right? See all the green, all the flowers start coming up. It’s really great.

Ryan Gorman  

I live by the beach too, so it’s actually really nice. I can walk right over whenever I like. So those work, work from home days are great.

Mary MacNamara  

Love it. Thank you so much.

Ryan Gorman  

Yeah. Thank you, Mary. I appreciate it

Mary MacNamara  

Yeah. Thank you, listeners. We’ll see you on the next podcast.