Take Stock In The Futures

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What makes index futures the big-payoff (or big-loss) gambles they are is the leverage: Margins are only one-fifth those of the 50% required in the stock market. So, as practitioners have started to proclaim, "you get more bang for the buck." But index futures are not merely educated dice rolls. For the same small fee, a money manager of a large portfolio might hedge his or her portfolio at questionable market junctures -- certainly a noble endeavor, despite Dow Jones's protests. (Curiously, say observers, institutions have yet to catch on to the benefits.) And an investor with an exposed position in naked stock options or, say, a short position in stocks, would do well to clothe himself in cheap futures protection from time to time.

Once you're in a wagering frame of mind, the questions are, which is the best contract, and what is the best tactic? The most popular version so far has been that of the Chicago Mercantile Exchange. One large money manager speculating in stock futures attributes this to the exchange's liquidity; the investment firm trades 100 contracts at a time, and finds that the CME can digest such large orders handily. The promotion-minded CME has quickly gained a reputation as a good order filler, a function of its experienced floor traders and pool of in-house trading pit speculators known as "locals." But probably the major reason for the CME's early lead is that among the three indexes, the S&P 500 is the most widely recognized.

An attraction of the Kansas City VLA contract is that its index undergoes wider swings than the other two. This is because it includes some faster-moving Amex and OTC stocks, and because it is not weighted in favor of ponderous blue-chip issues. Thus beyond the one-to-one protection a hedger with a $60,000 portfolio might get from the S&P and the NYSE indexes, VLA tacks on an extra fraction; speculators, too, get a faster run for their money. In one particularly hectic stretch recently, the Value Line average was down about four points, while the NYSE dropped only 1 1/2; at the two-to-one multiple that pertains, the VLA outdid its rival by 33%. Furthermore, the VLA occasionally leads the weighted averages in anticipating trends.

But, traders report, Kansas City suffers liquidity problems. That is all right if you buy a far-out contract and sit with it for a while. But speculating traders jump in to grab a handful of contracts in one hour and dispose of them for quick profits a few hours or a day or two later. An exchange that cannot offer close markets is shunned by such in-and-out traders, who are wary of not being able to jettison positions in a hurry -- often via automatic stop-loss orders -- at reasonable prices. For its part, Kansas City is mounting a well-prepared educational campaign, and is steadily increasing its volume, thus enhancing liquidity.

One thing NYFE has going for it is fast and tight executions. Speculators feel comfortable with NYFE contracts, but they don't appreciate NYFE's comparatively high commissions. Because speculators are apt to trade 10 NYFEs for five of either of the other stock market futures, commissions are nearly double. A round trip may cost only about $20 at a discount broker for any of the three, but if you multiply that by 10 contracts, a healthy chunk is taken out of potential daily profits. NYFE's best attraction is the high degree of correlation between its contract and the spot price: On 9 out of 10 trading days, says NYFE, its contract moves in tandem with the index.

Chances are index futures will be treated like commodities profits by the Internal Revenue Service and thus subject to a tax of only 32%, no matter how short the holding period, which can be a matter of an hour or two. This summer, stock index futures were part of the Tax Correction Act of 1982 then before the House Ways and Means Committee; if passed, they would officially gain rank as a true commodity. Due to their leveraged status, however, they cannot be used in an IRA or Keogh.

Stock futures solve a problem that has beset traders ever since the Securities and Exchange Commission instituted its short-sale uptick rule in 1938. Because you can't sell short unless the stock involved has moved up to its current price prior to the short sale, it was difficult to get off shorts in falling markets. With the advent of futures, however, a trader is now able to establish a broad short position with no muss or fuss.

As stock market index futures become more widely used, trading techniques grow more intricate. One conservative approach borrowed from real-commodity trading is the spread, in which the spreader takes opposite positions in a near contract and one further out. Savvy market students are also examining index futures for possible sentiment-indicator applications. Contracts have been trading mostly between a 2% premium (that is, the contract is valued 2% higher than the spot index behind it) and a 2% discount. As soon as enough empirical evidence is in, undoubtedly the quality of index futures trading will become a significant technical "signal."

But such considerations are only the beginning of what promises to be Wall Street's fastest-paced game since the infamous short-squeezing pools of the 1920s. Already two variations are on the boards. One is to diversify the underlying commodity, writing contracts, for example, on specific industry groups such as computers and semiconductors, or on divisions of the market like high capitalization stocks or transportation.

Better still will be the most abstract function yet devised for using money: options on index futures -- a thrice-removed dynamic of capital investment. Applications to trade such options have already been filed with the federal regulatory body, the Commodity Futures Trading Commission. Options on stock futures will be an irresistible field. Their lure will be that losses can be fixed while positions can be taken on broad market moves. And it is always easier to predict which way the market is about to go than to pick the individual stocks within it.

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