Frequently Asked Questions 
31/08/2009 
 

Chapter 7 Products - Derivatives Market

7.3

Stock Futures

 

7.3.1    

What are stock futures?

A stock futures contract is a legally binding commitment under which the contracting parties agree to buy or sell financial exposure equivalent to a specific amount (contract multiplier) of shares of the underlying stock at a predetermined price (contracted price) on a specified future date.

As stock futures contracts are cash settled, there is no physical delivery of shares when the contract expires. Upon expiry, profits and losses are credited or debited to the margin account of the contract holder in an amount equal to the difference between the contracted price and the final settlement price multiplied by the contract multiplier.

The final settlement price is the average of the following values for the underlying stock as quoted on the securities market:

  1. The best bid and offer prices taken at five-minute intervals from five (5) minutes after the start of, and up to five (5) minutes before the end of, the Continuous Trading Session of The Stock Exchange of Hong Kong Limited, or SEHK, a wholly-owned subsidiary of HKEX; and


  2. The closing price as quoted by SEHK.

    To offset an open short stock futures position before expiry, a seller of a stock futures contract simply buys back the contract while a buyer sells an identical stock futures contract to close the open long position.

 

7.3.2

What investment objectives can be achieved with stock futures trading?

Stock futures trading involves a smaller capital outlay that stock purchasing and allows leverage trading both on the upside and downside.  Investors only need to pay a margin equivalent to a fraction of the value of the underlying stock, but a number of investment objectives can be attained, including:

Pure Trading
Pure trading is mainly based on unidirectional investment strategies, where an investor buys or sells a specific quantity of futures contracts based on his own projection of the movement of the underlying stock.

Hedging
The purpose of hedging is to offset the negative impact of market moves on a portfolio’s overall return.

Risk management and transfer
Stock futures trading provides an efficient mechanism for allocating price risk from those who wish to avoid the price risk in stock holding to those who are interested in bearing the price risk for a potential return, and hence, can help reduce the price risk inherent in stock investment.

Arbitrage opportunities
Arbitrage refers to profiting from the difference between the prices of similar financial instruments in the futures and securities markets by buying low in one market and selling high in another.  Stock futures' prices are linked to the underlying stocks, so any deviation between the price of the underlying stock and the futures is likely to attract the attention of arbitragers.

Spread trading opportunities
Stock futures provide opportunities for investors to trade on the relative performance of difference stocks via spread trading.

 

7.3.3

What are the factors affecting the price of stock futures?

Cost of carry affects the pricing of stock futures.  Without the dividend factor, the theoretical price of a stock futures contract is equal to the cost of buying the underlying stock and holding it until the expiry date.

Taking into account the dividend payout of the underlying stock, the theoretical stock futures price is made up of three factors, including:

  • the underlying stock's price;
  • the interest cost of holding the underlying stock; and
  • the dividends paid to the holder of the underlying stock before the expiry of the stock futures contract.

 

7.3.4

How will a stock futures contract be affected if there is any "capital adjustment" to the underlying stock?

Any change of the capital structure of the issuer of the underlying stock by way of rights issue, bonus issue, etc may affect the price of the underlying stock as the stock goes ex-rights or when the change takes effect.  Any open interest may be affected as well.

Other factors being equal, the value of a shareholder's portfolio will not change on the ex-date. But for buyers or holders of stock futures, the case is different. If both the contracted price and contract multiplier of the stock futures remain unchanged, any adjustment to the stock price will have an unreasonable and unfair impact on the value of the stock futures position.

The HKFE will decide the adjustment ratio based on the principle of maintaining the fair value of futures contracts, and adjustment will only be made in case of any material change.  HKFE will publish the details of any adjustment and its Exchange Participants (ie futures brokers) are required to notify their clients of such adjustments.

 

7.3.5

Is short selling allowed in stock futures trading?

Short selling of stock futures is allowed.  A key at traction of stock futures is that they can be used as a substitute for short selling of the underlying stock. Short selling of underlying stocks is subject to the uptick rule restriction that forbids investors from selling short when a stock's price is below the best current ask price. There is, however, no such restriction in the short selling of stock futures.  Besides, according to current market regulations, investors should not sell short a stock unless a stock borrowing agreement is in place.  Investors who borrow stock face an added cost as they are required to pay interest to the lender.  As stock futures are cash settled, investors are only required to pay margin to establish a short position.  There is no need to find a stock lender so stock borrowing costs can be saved.  

For further details, please refer to "Stock Futures" of "Derivatives Products" under the "Products & Services" section of the HKEX website.