- 2001: Volume 10, No. 3 Exchanges Draw Swords for Single Stock Futures

It’s not too often in the futures industry that the rest of the world gets a jump on the United States. Innovation is supposed to start and finish in Chicago, birthplace of commodity futures, financial futures, equity index futures…you name it. Yet it so happens that Chicago of late has been reduced to watching its foreign competitors launch what could end up becoming the biggest derivatives market of them all—single-stock futures.

They already trade "single-stocks" in Sydney and Hong Kong, and in London and Barcelona. (A commonly accepted term is not expected to be agreed upon any time soon. Single-Stock Futures are called Individual Share Futures in Australia, and Universal Stock Futures in the United Kingdom.) It’s London that looms as the most threatening competitor. On the LIFFE exchange there, they trade futures on U.S. stocks as well as European stocks (Asia-Pacific stocks won’t be far behind), and are therefore getting a head-start on building liquidity, which is the essence of a successful futures market, and this could dent the prospects of the futures exchanges in America. The 21 U.S. stocks on LIFFE are all well-known, ranging from AT&T Corp. to Wal-Mart Stores, Inc. (See Table 1)

Table 1

U.S. Single-Stock Futures Traded on LIFFE As of May 14, 2001
American International Group Inc. Amgen Inc. AT&T Corp. AOL Time Warner Inc. Bristol-Myers Squibb Company Cisco Systems Inc. Citigroup Inc. EMC Corporation Exxon Mobil Corp. General Electric Company Intel Corp.	International Business Machines Corp. JDS Uniphase Corporation Juniper Networks Inc. Merck & Co. Inc. Microsoft Corp. Oracle Corporation Pfizer Inc. Qualcomm Inc. Sun Microsystems Inc. Wal-Mart Stores Inc.
Source: London International Financial Futures Exchange

When many markets have seen little action lately, with the exception of energies and indexes, the U.S. futures industry is in need of a boost right now. Reduced prosperity is reflected in the consolidations taking place in the brokerage sector, notably Refco’s acquisitions of Lind-Waldock, LFG and Main Street, and Man Financial Inc.’s buying First American. So the arrival of single-futures as a highly-promising new product would ostensibly be a big help in reviving spirits, and profits. Or would it?

In the hotly competitive U.S. exchange arena, there is no sure thing, as U.S. futures exchanges are being reminded in the run-up to single-stock trading. A principal reason this time is that, for the first time, stock exchanges and options exchanges have taken a fancy to futures. And it won’t be just a passing fancy. (Under the terms of the Commodity Futures Modernization Act passed in December 2000, individual investors will be able to trade single-stock futures on December 21, 2001. Institutions may be able to trade them as early as August 21.)

In March, Nasdaq and announced a partnership with LIFFE to develop single-stock futures on global stocks, employing an electronic platform. Brian Williamson, LIFFE’s Chairman, confidently stated: "The strength of Nasdaq’s brand and its pre-eminent position in the U.S. equity market will make our single stock futures offering a compelling choice for both retail and institutional customers in the U.S., as well as in Europe and beyond. As a first step, LIFFE and Nasdaq together are taking the revolution which LIFFE started, to the biggest capital market in the world, the United States of America."

As if the Nasdaq/LIFFE news wasn’t enough for the futures exchanges to stomach, along came the powerful Chicago Board Options Exchange (CBOE) to announce its forthcoming entry into single-stock futures trading, with Chairman and CEO William J. Brodsky declaring that it was the CBOE’s intention to "dominate the field." CBOE single-stock futures would trade in a combination of electronic trading and open outcry trading—although it hasn’t yet been decided whether the contracts would be settled in cash or by physical delivery.

John J. Lothian, President of the Electronic Trading Division of The Price Futures Group, Inc., sees veteran exchange executive Brodsky as a key reason for believing that the CBOE is well-placed for single-stock futures. According to Lothian, "Brodsky has the advantage of having worked as a lawyer, as Executive Vice President of Operations at the American Stock Exchange, and as President and CEO of the Chicago Mercantile Exchange. He crosses boundaries easily, and single-stock futures will be a futures and securities industry changing product."

Three primary advantages cited for single-stock futures are lower trading costs, simplified short-selling, and the inclusion of futures with stocks and options in securities accounts. Although details of the legislation regarding margin requirements for single-stock futures are still to be determined, margins on single-stock futures will definitely be more attractive than margins on stocks. Also, it will be possible to sell a single-stock future short without the uptick requirement that exists for stocks. And traders with securities accounts will not need to open futures accounts.

Looking beyond these technical advantages, Lothian envisages single-stock futures transforming the industry because they are a trading vehicle and not an investment vehicle, as are physical securities. He adds: "We have a trading culture in America and the Internet and electronic and on-line trading have greatly amplified this characteristic of ours."

The "trading culture" notion is where the futures industry may hold a trump card—if not against the options exchanges, then certainly against the stock exchanges. As Lothian points out: "The first in/first out futures exchange electronic trading platforms offer a level playing field for all levels of trader. On the other hand, stocks are at the mercy of specialists, market makers and other traditional trading procedures." In other words, stock exchanges are structured for investors, not traders.

While Nasdaq and the CBOE have declared their intentions, the large futures exchanges such as the CME, the Chicago Board of Trade and the New York Mercantile Exchange are still waiting to announce their single-stock strategies. The timing couldn’t be better for a major battle because most futures exchanges are demutualizing and planning to go public, making them even more combative than usual. If there is ever a new product most of them would like to succeed at over the next year or two, it’s single-stock futures.

So will a foreign connection, such as LIFFE’s arrangement with Nasdaq, be vital to ultimate success? A clue to this will be if traders want a "global pool" of selected stocks to trade, rather than hundreds of lesser-known stocks. In fact, LIFFE is well on its way to establishing a collection of the best-known international stocks, including U.S. companies, with 65 single-stock futures listed.

Or will the CME go a step further and orchestrate a worldwide single-stock futures strategy through its Globex alliance that includes ParisBourseSBF of France, the Singapore Exchange, Brazil’s Bolsa de Mercadorias & Futuros, the Montreal Exchange, and Spain’s MEFF? (Incidentally, MEFF is already off to a commendable start with single-stocks).

Or will success lie in a domestic U.S. strategy that plays to the widespread "trading culture" and the immense success of stock index futures and equity options, with single-stock futures becoming a third equity derivative product to trade? The dramatic increase in equities trading since the introduction of equity options and stock index futures is hard to ignore.

With its Globex alliance and undisputed leadership in U.S. index futures, the CME is in a unique position to compete with the CBOE because it could operate domestic and international strategies simultaneously. The CBOE is without question a powerful force in its own right, and the common clearing facility it has with other U.S. options exchanges simply adds to its competitive strength.

The CME and the CBOE are known quantities, but the same can’t be said for the Nasdaq/LIFFE relationship which will remain untested until single-stock trading in the U.S. commences. On the other hand, if LIFFE can take full advantage of its early start (LIFFE started trading single-stock futures on January 29, 2001) and accumulate an impressive body of traders and liquidity, Nasdaq may be able to outmaneuver its U.S. counterparts.

Alex McCallum is the editorial director and forum moderator at INO.com, a web center for traders that specializes in futures and options information. He can be reached by e-mail at alex@ino.com.