Finance Benefits

OneChicago, LLC is the exchange for Single Stock Futures. Jointly owned by the IB Group, CME Group and Chicago Board Options Exchange, OneChicago offers fully electronic, liquid and transparent markets in 1464 SSF names with all trading cleared through the ‘AAA’ rated Options Clearing Corporation (OCC) which eliminates counterparty risk.

Single Stock Futures are simply futures contracts on individual stocks and a number of ETFs. Accordingly they offer the same delta exposure that trading in the underlying security offers but on much better financing terms.

The key is the competitive interest rate that is built into the price of the future. This built in rate provides:

1. Long Stock holders can reduce their cost of carrying positions.
2. Short Stock traders can increase their yield above their current rebate rates.
3. Idle cash can be invested in ‘synthetic’ Exchange Future for Physical (EFP) positions to earn yields that are higher then those being offered by brokerages. In addition SSF trading is an alternative to the current stock loan process as short delta seekers needing to borrow stock can instead use the SSF market to get the position they want without locating the stock. Beneficial owners can participate in the SSF market and increase their current rate of returns without assuming counterparty risk as all trades clear through the OCC.

Alternative to Securities Lending

4. Securities Lending is primarily a back-office function that effectively is an over-the-counter derivative transaction. Mutual funds and Pension plans (Funds) lend (actually sell) assets today with an agreement that they will get the asset back at some point in the future. During the interim they will not lose economic exposure to the position and will receive additional compensation for participation. This transaction is substantially similar to an EFP (Exchange Future for Physical) transaction using Single Stock Futures (SSF) but with some very important differences:
   • The SSF EFP is a trade on a regulated exchange.
   • SSF trade in a competitive environment where finance rates are established by multiple market participants.
   • Transparency in pricing.
   • No counterparty risk as all trades are cleared through the AAA rated Options Clearing Corporation (OCC).
   Securities lending is currently an operations function. However it should be viewed as a trading strategy and therefore be included in the investment manager’s responsibility. There are substantial profits being ceded to intermediaries that could accrue to the funds and their clients instead.

Hedging Position

• Basic hedging:
  After large price gains, an investor may anticipate that a stock will trade sideways for a time. Rather than selling the position, the investor could hedge by selling single stock futures. This strategy protects against price depreciation, while preserving ownership rights of the underlying position

• Fine-tune market exposure: Single Stock Futures could be used to invest in equities that might have more favorable short-term upside potential than an investor’s current holdings. Investors may fine-tune their market exposure using security futures without changing the composition of their cash equity portfolio

• Hedge 401(k) positions in company stock until the next selling period: Covenants in benefit plans sometimes prevent the selling of equity holdings except during prescribed periods. Individuals can use SSFs to hedge their exposure to company stock until the next selling period

• Hedging a diversified portfolio: Investors can increase or decrease their level of exposure to the overall market with futures contracts on an ETF that tracks a broad-based index such as the DJIA or S&P 500. A short ETF futures position may thereby provide a broad and cost-effective hedge against the impact of market movements on a diversified portfolio

Volatility Hedging

Anticipated and unanticipated corporate events such as earnings announcements, FDA rulings, mergers and acquisitions, and regulatory actions can trigger volatility. Suppose an institution is long a technology index futures contract and one of the companies in that index is scheduled to release its earnings after the close. That company’s price volatility may increase after the release. Rather than selling the index and relinquishing the potential benefits from favorable price movements, a more cost-effective alternative is to sell the SSF on that company’s stock in the amount it is represented in the index investment. This strategy hedges the expected volatility in the index in the near-term.

Diversification

Diversification is a cornerstone of modern portfolio theory. Successful diversification should in theory not only enhance returns, but also smooth their expected path. This is the objective of most investors who construct a sophisticated portfolio. The efficiency of security futures facilitates several diversification strategies:

• Pairs trading, value and relative strength investing: In pairs trading, one firm within an industry is bought and a competitor is simultaneously sold short. This provides an investor with exposure to the relative performance of the two companies with limited exposure to broader market and sector performance.

  More broadly, relative strength investing refers to taking contrary positions in under-performing and over-performing instruments. Typical matches may include stocks vs. their peers and stocks vs. a broad market. This type of strategy can be efficiently implemented using security futures.

Benchmark Overlay

Many fund managers allocate their assets to a number of outside professional asset managers. A subtle risk for the fund, however, is that each manager will keep a small portion of its assets in cash. This cash reserve can result in tracking error and under-performance by the fund. The difference that arises from this problem may be diminished through a completion fund or benchmark overlay.

• Matching equity benchmarks when cash positions are held:To mitigate the risk of holding cash reserves, the fund manager can use index futures or ETF futures to make up the difference between the percentage managers leave in cash and the benchmark.