New Futures: Big Risk for Small Fry?
By Susan Harrigan
STAFF WRITER
August 11, 2002
As if the violent up-and-down swings of the stock market weren't dangerous enough, individual investors will be offered a new way to gamble on them this fall.
Sometime in the fourth quarter, the futures industry, anxious to cash in on Americans' fascination with stocks, will introduce "single-stock" futures. Sold in 100-share contracts, the new instruments will be much less expensive than futures on stock indexes, such as the Standard & Poor's 500, which are used by large institutional investors to speculate and hedge risk and can cost hundreds of thousands of dollars.
But while the price may appeal to retail investors, some futures industry officials say they won't encourage mom-and-pop investors to buy single-stock contracts, which are extremely risky and require close monitoring. "This is not a product to be used by someone who has nothing more than a 'buy-and-hold' philosophy," said William Rainer, chairman of OneChicago, a Chicago-based exchange that is one of three places where single-stock futures will be traded. Buyers would need to educate themselves so they are "the equal of a professional" in the marketplace, Rainer said.
Nevertheless, some brokers are hyping the new instruments to the public as easy ways to place bets on a stock's direction, especially by "shorting," or gambling that a stock's price will fall. One brokerage's Web site describes single-stock futures as "one of the most significant events to rock the U.S. financial markets in decades."
Consumer advocates are worried. Barbara Roper, director of investor protection for the Consumer Federation of America, said average investors should "just say no." The new instruments are too complicated for most people, she says, and can result in huge losses if a bet goes wrong. "If recent experience in the market tells us anything, you don't want to exaggerate the volatility that's already built in," Roper says. With violent daily swings in major stock indices, this year's market has become by some measures the most volatile since 1938.
Single-stock futures, which have never been traded in the United States, are contracts requiring investors to take delivery of a stock on a particular date. They were first legalized in this country two years ago, but couldn't begin trading until regulators established the financial ground rules late last month.
The products will be traded electronically on three exchanges: OneChicago, which is a joint venture of Chicago-based futures and options exchanges; Nasdaq/Liffe, co-owned by Nasdaq and the London International Financial Futures and Options Exchange, and Island Futures Exchange.
Much of the risk connected with single-stock futures centers on the requirement that investors put down only 20 percent of a contract's cost, rather than paying for the entire purchase. That "margin" payment creates "leverage," or the possibility of a relatively large percentage gain (or loss) on the initial investment.
For instance, assume that a person betting on a price rise for a hypothetical company called Gloop Ink bought a futures contract on 100 shares of Gloop, currently selling at $50 per share, for $5,000. The margin deposit would be $1,000. If Gloop shares dropped $5, to $45 a share, the value of the futures contract falls to $4,500 for the 100 shares - which means that person has lost 50 percent of his or her deposit. By contrast, someone who paid $5,000 cash in the stock market for 100 Gloop shares would lose only 10 percent of the investment.
What's more, the futures contract expires on a predetermined date, forcing the investor to take a loss even if the stock is in a short-term swoon. An owner of actual shares can hold on indefinitely and ride out the turbulence.
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