Short Positions Offset Agains Long Position

Federal regulations permit trading in futures contracts on unmarried stocks (also known equally unmarried stock futures or SSFs) and narrow-based security indices (run across glossary beneath). This article describes what security futures are, how they differ from stock options, some of the risks they can pose, and how they are regulated.

Security futures involve a high degree of risk and are non suitable for all investors. As with any investment, if yous don't understand it, you shouldn't buy it.

With security futures, you may lose a substantial amount of money in a very short menstruum of time. The amount yous may lose is potentially unlimited and can exceed the amount yous originally deposit with your broker. This is because trading in security futures typically involves a high degree of leverage, with a relatively modest corporeality of coin controlling assets having a much greater value. Investors who are uncomfortable with this level of hazard should not trade security futures.

At that place are no security futures contracts currently listed for trading on U.S. exchanges. Before trading security futures, please read the Security Futures Take a chance Disclosure Statement.

Security Futures Basics

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What's a security futures contract?

A security futures contract is a legally binding agreement betwixt two parties to buy or sell a specific quantity of shares of a security (i.due east., common stock or an exchange-traded fund) or a narrow-based security index at a specified toll, on a specified engagement in the future (known every bit the settlement or expiration engagement). If you purchase a futures contract, y'all are inbound into a contract to purchase the underlying security and are said to be "long" the contract. Conversely, if yous sell a futures contract, you are entering into a contract to sell the underlying security and are considered "short" the contract. The price at which the contract trades (or the "contract toll") is determined by relative buying and selling interest on a regulated U.South. substitution.

Security Futures Contract Specifications

Contract size—Each security futures contract has a gear up size. The size of a security futures contract is determined by the regulated exchange on which the contract trades. For case, a security futures contract for a single stock may be based on 100 shares of the underlying stock. For narrow-based security indices, the value of the contract is the cost of the component securities times the multiplier set by the commutation as part of the contract terms.

Contract month—The month when the contract expires. There will exist several dissimilar contract months available for trading at any one time, and the number of contract months may vary from exchange to commutation.

Contract expiration, last trading mean solar day—The expiration of a security futures contract is established past the substitution on which the contract is listed. On the expiration day, the contract terminates. Typically, the last trading twenty-four hour period of a security futures contract volition exist the 3rd Friday of the expiring contract month, and the expiration solar day will be the following Sabbatum.

Fashion of settlement—Security futures may be settled past physical delivery of the underlying security or cash settlement. The terms of the contract dictate whether it is settled past greenbacks or physical commitment.

Offsetting Transactions

Prior to expiration of the contract, investors realize their current gains or losses past executing an offsetting sale or purchase in the same contract (i.e., an equal and opposite transaction to the i that opened the position).

Instance: Investor A is long i September ABC Corp. futures contract. To close out or offset the long position, Investor A would sell an identical September ABC Corp. contract.

Investor B is short 1 October XYZ Corp. futures contract. To close out or offset the brusque position, Investor B would buy an identical October XYZ Corp. contract.

Contract Expiration and Delivery

Any futures contract that hasn't been liquidated by an offsetting transaction before the contract's expiration date volition be settled at that day's settlement price (meet glossary beneath). The terms of the contract specify whether a contract volition exist settled by physical commitment—receiving or giving up the actual shares of stock—or past greenbacks settlement. Where physical delivery is required, a holder of a curt position must deliver the underlying security. Conversely, a holder of a long position must accept delivery of the underlying shares.

Where cash settlement is required, the underlying security is not delivered. Rather, any security futures contracts that are open are settled through a final cash payment based on the settlement toll. Once this payment is made, neither party has any further obligations on the contract.

Margin and Leverage

When a brokerage house lends you office of the funds needed to buy a security, such as common stock, the term "margin" refers to the amount of cash, or downwards payment, the customer is required to deposit. By contrast, you lot should be enlightened that a security futures contract is an obligation and is not an asset. The contract has no value every bit collateral for a loan. When yous enter into a security futures contract, you lot are required to pay a margin eolith or performance bond. These are practiced faith deposits to ensure your operation of obligations under the contract rather than down payments for the underlying securities.

For a relatively small corporeality of money (the margin requirement), a futures contract worth several times as much can be bought or sold. The smaller the margin requirement in relation to the underlying value of the futures contract, the greater the leverage. Because of this leverage, small changes in the price of the contract can result in large gains and losses in a short flow of time.

Margin requirements for security futures contracts would exist set up by the commutation on which the contract is traded, subject area to sure minimum standards gear up by law. The basic margin requirement is fifteen percent of the electric current value of the security futures contract, although some strategies may accept lower margin requirements. It is of import to understand that individual brokerage firms can, and in many cases do, require margin that is higher than the exchange requirements. Additionally, margin requirements may vary from brokerage house to brokerage firm.

Importantly, a brokerage firm can increase its "firm" margin requirements at whatever time without providing advance discover, and such increases could event in a margin phone call. You should thoroughly read and understand the customer agreement with your brokerage firm before entering into any transactions in security futures contracts.

Example: Assuming a security futures contract is for 100 shares of stock, if a security futures contract is established at a contract price of $l, the contract has a nominal value of $5,000 (see the definition of "nominal value" below in glossary). Currently, federal regulatory standards prescribe that margin requirements may exist as depression as 15 percent, which would require a margin deposit of $750. Presume the contract price rises from $50 to $53 (a $300 increment in the nominal value). This represents a $300 profit to the buyer of the futures contract, and a xl percent return on the $750 deposited as margin.

The reverse would exist true if the contract price decreased from $l to $47. This represents a $300 loss to the buyer, or 40 percent of the $750 deposited as margin. Thus, leverage can either benefit or harm an investor.

Notation that a 6 percentage decrease in the value of the contract resulted in a loss of xl percent of the margin deposited. A 15 percent decrease in the contract price ($50 to $42.50) would hateful a drop in the nominal value of the contract from $five,000 to $4,250, thereby wiping out 100 pct of the margin deposited on the security futures contract.

Adverse price movements that reduce the reserve below a specified level will therefore result in a need from your banker that y'all promptly deposit additional margin funds to your business relationship. Returning to our earlier case, the six per centum decrease in the value of the contract that resulted in the loss of 40 percentage of the margin deposit would reduce the margin eolith to $450. Therefore, the account holder would need to deposit $187.fifty in the margin account to heighten the margin level dorsum upwardly to 15 percentage of the electric current value of the contract ($4,250).

Considering of the always-nowadays possibility of margin calls, security futures contracts are not advisable if you cannot come up with the boosted funds on curt notice to run into margin calls on open futures positions. If you fail to run into a margin telephone call, your firm may close out your security futures position or sell avails in any of your accounts at the house to cover your margin deficiency. If your position is liquidated at a loss, yous will exist liable for the loss. Thus, you can lose substantially more than your original margin deposit.

Gains and Losses

Unlike stocks, gains and losses in security futures contracts are credited or debited to your account every 24-hour interval, based on the settlement price of the contracts at the close of that day'southward trading. If the daily settlement toll of a particular security futures contract rises, the buyer has a gain and the seller a loss. If due to losses your business relationship falls beneath maintenance margin requirements, yous may be required to place additional funds in your account to encompass the margin deficiency.

Where Are Security Futures Permitted To Trade?

By law, security futures contracts must trade on a regulated U.S. exchange. Each regulated U.S. exchange that trades security futures contracts is subject area to joint regulation by the Securities and Commutation Commission (SEC) and the Commodity Futures Trading Committee (CFTC). The exchanges that are registered with the SEC for the purpose of trading security futures include:

• CBOE Futures Exchange (CFE)
• Chicago Board of Merchandise (CBOT)
• Chicago Mercantile Exchange (CME)

Variety of Security Futures Contracts

Contract specifications may vary from contract to contract. For instance, most security futures contracts require you to settle by making physical delivery of the underlying security, as opposed to making a cash settlement. Advisedly review the settlement and delivery weather before entering into a security futures contract.

Differences Between Security Futures and Stock Options

Although security futures share some characteristics in common with stock options, these products differ significantly. Well-nigh chiefly, an option buyer may choose whether or not to exercise the option by the practise date. Options purchasers who neither sell their options in the secondary market nor practice them before they elapse will lose the corporeality of the premium they paid for each option, but they cannot lose more than the amount of the premium. A security futures contract, on the other mitt, is a binding agreement to buy or sell. Based upon movements in toll of the underlying security, holders of a security futures contract can gain or lose many times their initial margin deposit.

Security Futures Risks

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All security futures contracts involve risk, and there is no trading strategy that can eliminate it. Strategies using combinations of positions, such as spreads (see glossary beneath), may exist as risky as outright long or short futures positions. Trading in security futures requires knowledge of both the securities and the futures markets.

As noted in a higher place, before you trade security futures, y'all should read the Security Futures Hazard Disclosure Statement. And bear in mind the post-obit specific risks involved when trading security futures contracts:

• Trading security futures contracts may consequence in potentially unlimited losses that are greater than the amount you deposited with your broker. Every bit with any high-run a risk financial production, you should non hazard any money that you cannot afford to lose, such as your retirement savings, medical and other emergency funds, funds set bated for education or home ownership or funds required to meet your living expenses.

• Exist cautious of claims that you can make big profits from trading security futures. Although the high caste of leverage in futures can outcome in big and immediate gains, it can also issue in large and firsthand losses. As with whatever financial product, there is no such affair equally a "sure winner."
  
• Because of the leverage involved and the nature of futures transactions, yous may feel the furnishings of your losses immediately. Unlike holdings in traditional securities, gains and losses in security futures are credited or debited to your account on a daily ground at a minimum. If movements in the markets for security futures contracts or the underlying security subtract the value of your positions in security futures contracts, you may be required to have or make boosted funds bachelor to your carrying business firm equally margin. If your account is under the minimum margin requirements gear up by the substitution or the firm, your position may be liquidated at a loss, and you will be liable for whatever deficit in your account.
  
• Under some market conditions, it may be difficult or impossible to hedge or liquidate a position. Generally, you must enter into an offsetting transaction in order to liquidate a position in a security futures contract. If you cannot hedge or liquidate your position, whatever existing losses may continue to mount. Even if you tin hedge or liquidate your position, you may be forced to practise and so at a toll that involves a big loss. This can occur, for example:
  • If trading is halted due to unusual trading activeness in either the security futures contracts or the underlying security;
  • If trading is halted due to recent news events involving the issuer of the underlying security;
  • If estimator systems failures occur on an exchange or at the house carrying your position; or
  • If the marketplace is illiquid and therefore doesn't have enough trading interest to permit yous to become a expert price.
    
• Under some market place weather, the prices of security futures may non maintain their customary or anticipated relationships to the prices of the underlying security or index. These pricing disparities tin can occur, for example, when the market for the security futures contract is illiquid and lacks trading interest, when the primary market for the underlying security is closed or when the reporting of transactions in the underlying security has been delayed. For index products, this could besides occur when trading is delayed or halted in some or all of the securities that make upwards the alphabetize.
  
• Y'all may experience losses due to computer systems failures. As with any financial transaction, you may feel losses if your orders cannot exist executed unremarkably due to systems failures on a regulated exchange or at the firm carrying your position. Your losses may be greater if your brokerage firm does non have acceptable redundancy systems or procedures.
  
• Placing contingent orders, if permitted, such as "stop-loss" or "stop-limit" orders, will not necessarily limit your losses to the intended amount. Market conditions may brand it impossible to execute the gild or to get the end price.
  
• Day trading strategies involving security futures pose special risks. As with any financial product, seeking to profit from intra-24-hour interval price movements poses a number of risks, including increased trading costs, greater exposure to leverage and heightened competition with professional traders.

• Tax implications. The tax implications of security futures may be complicated. You should consult a tax adviser earlier trading in these products.

Security Futures Regulation and Investor Protection

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Who Regulates Security Futures?

The CFTC and the SEC jointly regulate the trading of futures on unmarried securities and narrow-based security indexes (i.e., security futures products), which have features of both futures and securities. Just as FINRA, subject to SEC oversight, oversees the securities industry past requiring registration of banker-dealers and subjecting members to its rules, examinations, and enforcement authority, the NFA performs like functions every bit the cocky-regulatory arrangement for the futures industry.

Finding and Choosing a Broker

Equally an individual investor, you cannot merchandise straight on an exchange. Security futures transactions for individual investors must exist handled by a broker. Near brokers are honest, competent professionals—and there are regulators, like FINRA, to help make sure that the few who are not are identified and disciplined—sometimes fifty-fifty barred from the manufacture.

Before y'all practise business with any security futures professional or firm, you lot should check out their background. Both FINRA BrokerCheck and the NFA's Background Amalgamation Condition Information Center (BASIC) offer online admission to important data almost your broker or firm. These sites can provide a wealth of information about the professional background, business practices and carry of firms and brokers. Your land securities regulator besides may have boosted information about securities professionals.

But there is more to finding a broker than knowing which ones might not be trustworthy. The central is finding the broker and house that make you feel comfortable and best run across your personal fiscal needs.

Security Futures Account Protection

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Security futures positions may exist held in either a securities or futures account. The protections for your funds and security futures positions differ depending on whether the account is a securities business relationship or a futures account, so brand sure you empathise the regulatory protections bachelor to your funds and positions if your business firm fails. Your brokerage firm must tell you whether your security futures positions will be held in a securities account or a futures account. You also may take a selection about which type of business relationship to concord your funds and positions.

• Protections for Securities Accounts — If y'all concord security futures contracts in a securities account, SEC rules prohibit a brokerage firm from using your funds and securities to finance its business. As a event, the brokerage house is required to set aside funds equal to the net of all its excess payables to its customers (money the firm owes customers) over receivables from customers (money customers owe the firm). These rules also require the firm to segregate (concur separately) a customer's fully paid and backlog margin securities.

  If the brokerage house becomes insolvent, the Securities Investor Protection Corporation (SIPC) protects cash and "securities" every bit divers under the Securities Investor Protection Act. SIPC protection also is available with respect to certain security futures contracts, and options on such contracts, where those instruments are held in a portfolio margining account carried by a SIPC-fellow member brokerage firm equally a securities account pursuant to a portfolio margining program approved by the SEC. Nigh brokers who are registered with the SEC are SIPC members; those few that are not must disclose this fact to their customers. To find out if your brokerage firm is a member of SIPC, you can bank check SIPC's database.

  SIPC coverage is limited to $500,000 per customer, including up to $250,000 for cash. This coverage is limited to protecting funds and securities if the broker holding these avails becomes insolvent; these protections do not cover market losses. To learn more, read our article on SIPC protection.

• Protection for Futures Accounts — Cash held in a futures account must be segregated from the brokerage house'due south own funds and cannot exist borrowed or otherwise used for the house's own purposes. The business firm cannot utilise your funds to margin or guarantee the transactions of another customer. The firm must add its ain funds to the segregated account to cover some other client's debits or deficits. If the firm becomes insolvent, you may non exist able to recover the full amount of your funds. Your account is non insured; however, customers with funds in segregation receive priority in defalcation proceedings.

What to Do When Problems Arise

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Review your accounts statements and merchandise confirmations. If you believe you lot accept been wronged or see a mistake in your account, human action quickly. Immediately question any transaction you do not understand or did non qualify. Don't be timid or ashamed to complain. The securities industry needs your aid so it can operate successfully. Here are the steps yous should take:

• If you think it'south a minor mistake, talk to your broker. This may exist the fastest way to resolve the problem.
• If you tin can't resolve the problem with your broker or y'all believe your broker engaged in unauthorized transactions or other serious misconduct, report the matter in writing to the firm's direction or compliance section.
• If you and your firm withal can't resolve the problem, you lot have several options for resolving your dispute:
  • Regulatory complaint programs. Investigating complaints from investors is a significant function of FINRA, the SEC and the NFA. Considering the focus of these investigations is regulatory rather than compensatory, you lot should consider other avenues of dispute resolution if you are seeking to recover coin or securities. You can file a complaint with FINRA if it's against a brokerage business firm and its employees. NFA handles complaints confronting futures professionals. You likewise tin file a complaint with the SEC.
  • CFTC Reparations Plan. The CFTC Reparations Programme resolves disputes against commodity futures professionals that are registered with the CFTC and declared to have violated the Article Exchange Human action or CFTC regulations. You may seek actual damages (such as out-of-pocket trading losses). If y'all prevail, y'all also recover your filing fee.
  • Arbitration and Arbitration. Both FINRA and the NFA offer mediation and arbitration services. Arbitration is a dispute resolution mechanism that determines liability and whether parties are entitled to damages. Both actual and castigating amercement may be awarded.
  • Litigation. Although nearly new account agreements crave you to pursue arbitration or arbitration, you lot may be able to bring an action in federal or state court.

Circumspection! Exist aware that certain state and federal laws limit the time you may have for filing a lawsuit, arbitration or CFTC reparation claim.

Checklist: Before You Trade

Read the Security Futures Chance Disclosure Argument, which includes a glossary of terms.

Check your broker's groundwork past visiting either FINRA BrokerCheck or the NFA's Groundwork Affiliation Condition Information Middle (Basic).

Realize that security futures will expire and, unless you offset your position, you may take to deliver or accept commitment of the underlying security.

Have access to funds in case your losses exceed your original investment.

Empathize the need to follow closely the price fluctuation of the underlying stock for any futures contract you might buy or sell.

Boosted Resource

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• CFTC: Security Futures Products
• FINRA's Security Futures Folio

Glossary

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Futures contract—A futures contract is: (1) an agreement to purchase or sell a commodity for commitment in the future; (ii) at a price determined at initiation of the contract; (three) that obligates each party to the contract to fulfill information technology at the specified price; (four) that is used to assume or shift gamble; and (5) that may be satisfied by delivery or offset.

Narrow-based security index—In general, an index that has any one of the following four characteristics: (1) it has nine or fewer component securities; (2) any one of its component securities brand up more 30 percent of its weighting; (iii) the five highest weighted component securities together make upward more than 60 percent of its weighting; or (4) the everyman weighted component securities making up, in the aggregate, 25 per centum of the index's weighting have an aggregate dollar value of average daily trading volume of less than $50 million (or in the example of an index with 15 or more component securities, $30 million).

Nominal value—The face value of the futures contract, obtained past multiplying the contract price by the number of shares or units per contract. If XYZ stock index futures are trading at $50.25 and the contract is for 100 shares of XYZ stock, the nominal value of the futures contract would be $5,025.

Settlement price—(1) The daily price that the clearing organization uses to mark open up positions to market for determining profit and loss and margin calls and for invoicing deliveries in physical delivery contracts; (2) The price at which open cash settlement contracts are settled on the last trading day and open physical delivery contracts are invoiced for commitment.

Spread—(1) Property a long position in one futures contract and a short position in a related futures contract or contract calendar month in social club to profit from an anticipated modify in the price relationship between the ii; (2) The cost deviation between two contracts or contract months.

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Source: https://www.finra.org/investors/learn-to-invest/types-investments/security-futures

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