Security Futures Risk
Disclosure Statement
June 2016
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Risk Disclosure Statement For Security Futures
Contracts
This disclosure statement discusses the
characteristics and risks of standardized security
futures contracts traded on regulated U.S. exchanges.
At present, regulated exchanges are authorized to
list futures contracts on individual equity securities
registered under the Securities Exchange Act of 1934
(including common stock and certain exchange-
traded funds and American Depositary Receipts),
as well as narrow-based security indices. Futures
on other types of securities and options on security
futures contracts may be authorized in the future. The
glossary of terms appears at the end of the document.
Customers should be aware that the examples in
this document are exclusive of fees and commissions
that may decrease their net gains or increase their
net losses. The examples also do not include tax
consequences, which may differ for each customer.
FINRA and the National Futures Association
(NFA), require members to deliver this
Security Futures Risk Disclosure Statement
to customers at or prior to the time a
customer’s account is approved for trading
security futures. Customers also may receive
revisions from time to time.
This Security Futures Risk Disclosure
Statement has been prepared by FINRA
and NFA with significant assistance from
other futures and securities self-regulatory
organizations.
Additional copes of this document may be
obtained by contacting FINRA MediaSource
at (240) 386-4200, or the NFA Information
Center at (312) 781-1410, or from FINRA’s
Web Site at www.finra.org, or NFA’s Web Site
at www.nfa.futures.org.
TABLE OF CONTENTS
Risk Disclosure Statement For Security
Futures Contracts 1
Section 1 | Risks Of Security Futures 4
1.1. Risks of Security Futures Transactions 4
1.2. General Risks 4
Section 2 | Description Of A Security
Futures Contract 8
2.1. What Is a Security Futures Contract? 8
2.2. Purposes of Security Futures 10
2.3. Where Security Futures Trade 13
2.4. How Security Futures Differ from
the Underlying Security 14
2.5. Comparison to Options 16
2.6. Components of a Security Futures
Contract 18
2.7. Trading Halts 20
2.8. Trading Hours 21
Section 3 | Clearing Organizations And
Mark-To-Market Requirements 22
Section 4 | Margin And Leverage 25
5.1. Cash Settlement 29
Section 5 | Settlement 29
5.2. Settlement by Physical Delivery 30
Section 6 | Customer Account Protections 31
6.1. Protections for Securities Accounts 32
6.2. Protections for Futures Accounts 33
Section 7 | Special Risks For Day Traders 35
Section 8 | Other 36
8.1. Corporate Events 36
8.2. Position Limits and Large Trader Reporting 37
8.3. Transactions on Foreign Exchanges 39
8.4. Tax Consequences 39
Section 9 | Glossary Of Terms 40
August 2010 |Supplement To The Security
Futures Risk Disclosure Statement 47
April 2014 | Supplement To The Security
Futures Risk Disclosure Statement 48
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1.1. Risks of Security Futures Transactions
Trading security futures contracts may not be suitable
for all investors. You may lose a substantial amount of
money in a very short period of time. The amount you
may lose is potentially unlimited and can exceed the
amount you originally deposit with your broker. This
is because futures trading is highly leveraged, with a
relatively small amount of money used to establish a
position in assets having a much greater value. If you
are uncomfortable with this level of risk, you should
not trade security futures contracts.
1.2. General Risks
Trading security futures contracts involves risk and
may result in potentially unlimited losses that are
greater than the amount you deposited with your
broker. As with any high risk financial product, you
should not risk any funds that you cannot afford
to lose, such as your retirement savings, medical
and other emergency funds, funds set aside for
purposes such as education or home ownership,
proceeds from student loans or mortgages, or
funds required to meet your living expenses.
Be cautious of claims that you can make large
profits from trading security futures contracts.
Although the high degree of leverage in security
futures contracts can result in large and immediate
gains, it can also result in large and immediate
losses. As with any financial product, there is no
such thing as a “sure winner.”
Because of the leverage involved and the nature
of security futures contract transactions, you
may feel the effects of your losses immediately.
Gains and losses in security futures contracts are
credited or debited to your account, at a minimum,
on a daily basis. If movements in the markets
for security futures contracts or the underlying
security decrease the value of your positions in
security futures contracts, you may be required to
have or make additional funds available to your
carrying firm as margin. If your account is under
the minimum margin requirements set by the
exchange or the brokerage firm, your position may
be liquidated at a loss, and you will be liable for the
deficit, if any, in your account. Margin requirements
are addressed in Section 4.
Under certain market conditions, it may be difficult
or impossible to liquidate a position. Generally,
you must enter into an offsetting transaction in
order to liquidate a 4 position in a security futures
contract. If you cannot liquidate your position in
security futures contracts, you may not be able
to realize a gain in the value of your position or
prevent losses from mounting. This inability to
liquidate could occur, for example, if trading is
halted due to unusual trading activity in either the
security futures contract or the underlying security;
if trading is halted due to recent news events
involving the issuer of the underlying security; if
systems failures occur on an exchange or at the
firm carrying your position; or if the position is on
an illiquid market. Even if you can liquidate your
position, you may be forced to do so at a price that
involves a large loss.
Under certain market conditions, it may also be
difficult or impossible to manage your risk from
open security futures positions by entering into
an equivalent but opposite position in another
contract month, on another market, or in the
underlying security. This inability to take positions
to limit your risk could occur, for example, if trading
is halted across markets due to unusual trading
activity in the security futures contract or the
underlying security or due to recent news events
involving the issuer of the underlying security.
SECTION 1
Risks Of Security Futures
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Under certain market conditions, the prices of
security futures contracts may not maintain their
customary or anticipated relationships to the prices
of the underlying security or index. These pricing
disparities could occur, for example, when the
market for the security futures contract is illiquid,
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, it could also occur
when trading is delayed or halted in some or all
of the securities that make up the index.
You may be required to settle certain security
futures contracts with physical delivery of the
underlying security. If you hold your position in a
physically settled security futures contract until
the end of the last trading day prior to expiration,
you will be obligated to make or take delivery of
the underlying securities, which could involve
additional costs. The actual settlement terms
may vary from contract to contract and exchange
to exchange. You should carefully review the
settlement and delivery conditions before entering
into a security futures contract. Settlement and
delivery are discussed in Section 5.
You may experience losses due to systems failures.
As with any financial transaction, you may
experience losses if your orders for security futures
contracts cannot be executed 6 normally due to
systems failures on a regulated exchange or at the
brokerage firm carrying your position. Your losses
may be greater if the brokerage firm carrying your
position does not have adequate back-up systems
or procedures.
All security futures contracts involve risk, and
there is no trading strategy that can eliminate it.
Strategies using combinations of positions, such as
spreads, may be as risky as outright long or short
positions. Trading in security futures contracts
requires knowledge of both the securities and the
futures markets.
Day trading strategies involving security futures
contracts and other products pose special risks.
As with any financial product, persons who seek
to purchase and sell the same security future in
the course of a day to profit from intra-day price
movements (“day traders”) face a number of special
risks, including substantial commissions, exposure
to leverage, and competition with professional
traders. You should thoroughly understand these
risks and have appropriate experience before
engaging in day trading. The special risks for day
traders are discussed more fully in Section 7.
Placing contingent orders, if permitted, such
as “stop-loss” or “stop-limit” orders, will not
necessarily limit your losses to the intended
amount. Some regulated 7 exchanges may permit
you to enter into stop-loss or stop-limit orders
for security futures contracts, which are intended
to limit your exposure to losses due to market
fluctuations. However, market conditions may
make it impossible to execute the order or to get
the stop price.
You should thoroughly read and understand the
customer account agreement with your brokerage
firm before entering into any transactions in
security futures contracts.
You should thoroughly understand the regulatory
protections available to your funds and positions
in the event of the failure of your brokerage firm.
The regulatory protections available to your funds
and positions in the event of the failure of your
brokerage firm may vary depending on, among
other factors, the contract you are trading and
whether you are trading through a securities
account or a futures account. Firms that allow
customers to trade security futures in either
securities accounts or futures accounts, or both, are
required to disclose to customers the differences in
regulatory protections between such accounts, and,
where appropriate, how customers may elect to
trade in either type of account.
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2.1. What Is a Security Futures Contract?
A security futures contract is a legally binding
agreement between two parties to purchase or
sell in the future a specific quantity of shares of a
security or of the component securities of a narrow-
based security index, at a certain price. A person
who buys a security futures contract enters into a
contract to purchase an underlying security and is
said to be “long” the contract. A person who sells a
security futures contract enters into a contract to sell
the underlying security and is said to be “short” the
contract. The price at which the contract trades
(the “contract price”) is determined by relative buying
and selling interest on a regulated exchange.
In order to enter into a security futures contract,
you must deposit funds with your brokerage firm
equal to a specified percentage (usually at least 20
percent) of the current market value of the contract
as a performance bond. Moreover, all security futures
contracts are marked-to-market at least daily, usually
after the close of trading, as described in Section 3
of this document. At that time, the account of each
buyer and seller reflects the amount of any gain or
loss on the security futures contract based on the
contract price established at the end of the day for
settlement purposes (the “daily settlement price”).
An open position, either a long or short position, is
closed or liquidated by entering into an offsetting
transaction (i.e., an equal and opposite transaction
to the one that opened the position) prior to the
contract expiration. Traditionally, most futures
contracts are liquidated prior to expiration through
an offsetting transaction and, thus, holders do not
incur a settlement obligation.
Security futures contracts that are not liquidated prior
to expiration must be settled in accordance with the
terms of the contract. Some security futures contracts
are settled by physical delivery of the underlying
security. At the expiration of a security futures
contract that is settled through physical delivery, a
person who is long the contract must pay the final
settlement price set by the regulated exchange or
the clearing organization and take delivery of the
underlying shares. Conversely, a person who is short
the contract must make delivery of the underlying
shares in exchange for the final settlement price.
Other security futures contracts are settled through
cash settlement. In this case, the underlying security
is not delivered. Instead, any positions in such security
futures contracts that are open at the end of the last
trading day are settled through a final cash payment
based on a final settlement price determined by the
exchange or clearing organization. Once this payment
is made, neither party has any further obligations on
the contract.
Physical delivery and cash settlement are discussed
more fully in Section 5.
SECTION 2
Description Of A Security Futures Contract
Examples:
Investor A is long one September XYZ Corp.
futures contract. To liquidate the long position
in the September XYZ Corp. futures contract,
Investor A would sell an identical September
XYZ Corp. contract.
Investor B is short one December XYZ Corp.
futures contract. To liquidate the short position
in the December XYZ Corp. futures contract,
Investor B would buy an identical December
XYZ Corp. contract.
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2.2. Purposes of Security Futures
Security futures contracts can be used for speculation,
hedging, and risk management. Security futures
contracts do not provide capital growth or income.
Speculation
Speculators are individuals or firms who seek to
profit from anticipated increases or decreases in
futures prices. A speculator who expects the price of
the underlying instrument to increase will buy the
security futures contract. A speculator who expects
the price of the underlying instrument to decrease
will sell the security futures contract. Speculation
involves substantial risk and can lead to large losses
as well as profits.
Price of XYZ
at Liquidation
Customer A
Profit/Loss
Customer B
Profit/Loss
$55 $500 - $500
$50 $0 $0
$45 - $500 $500
The most common trading strategies involving
security futures contracts are buying with the hope
of profiting from an anticipated price increase and
selling with the hope of profiting from an anticipated
price decrease. For example, a person who expects
the price of XYZ stock to increase by March can buy
a March XYZ security futures contract, and a person
who expects the price of XYZ stock to decrease by
March can sell a March XYZ security futures contract.
The following illustrates potential profits and losses
if Customer A purchases the security futures contract
at $50 a share and Customer B sells the same contract
at $50 a share (assuming 100 shares per contract).
Speculators may also enter into spreads with the
hope of profiting from an expected change in price
relationships. Spreaders may purchase a contract
expiring in one contract month and sell another
contract on the same underlying security expiring in
a different month (e.g., buy June and sell September
XYZ single stock futures). This is commonly referred to
as a “calendar spread.” Spreaders may also purchase
and sell the same contract month in two different but
economically correlated security futures contracts. For
example, 12 if ABC and XYZ are both pharmaceutical
companies and an individual believes that ABC will
have stronger growth than XYZ between now and
June, he could buy June ABC futures contracts and
sell June XYZ futures contracts. Assuming that each
contract is 100 shares, the following illustrates how
this works.
Opening
Position
Price at
Liquidation
Gain or
Loss
Price at
Liquidation
Gain or
Loss
Buy ABC at 50 $53 $300 $53 $300
Sell XYZ at 45 $46 -$100 $50 -$500
Net Gain or Loss $200 -$200
Speculators can also engage in arbitrage, which is
similar to a spread except that the long and short
positions occur on two different markets. An arbitrage
position can be established by taking an economically
opposite position in a security futures contract on
another exchange, in an options contract, or in the
underlying security.
Hedging
Generally speaking, hedging involves the purchase
or sale of a security future to reduce or offset the risk
of a position in the underlying security or group of
securities (or a close economic equivalent). A hedger
gives up the potential to profit from a favorable
price change in the position being hedged in order
to minimize the risk of loss from an adverse price
change.
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An investor who wants to lock in a price now for an
anticipated sale of the underlying security at a later
date can do so by hedging with security futures. For
example, assume an investor owns 1,000 shares of
ABC that have appreciated since he bought them. The
investor would like to sell them at the current price of
$50 per share, but there are tax or other reasons for
holding them until September. The investor could sell
ten 100- share ABC futures contracts and then buy
back those contracts in September when he sells the
stock. Assuming the stock price and the futures price
change by the same amount, the gain or loss in the
stock will be offset by the loss or gain in the futures
contracts.
Price in
September
Value of
1,000 Shares
of ABC
Gain or Loss
on Futures
Effective
Selling Price
$40 $40,000 $10,000 $50,000
$50 $50,000 $0 $50,000
$60 $60,000 - $10,000 $50,000
Hedging can also be used to lock in a price now for
an anticipated purchase of the stock at a later date.
For example, assume that in May a mutual fund
expects to buy stocks in a particular industry with
the proceeds of bonds that will mature in August.
The mutual fund can hedge its risk that the stocks
will increase in value between May and August by
purchasing security futures contracts on a narrow-
based index of stocks from that industry. When the
mutual fund buys the stocks in August, it also will
liquidate the security futures position in the index.
If the relationship between the security futures
contract and the stocks in the index is constant, the
profit or loss from the futures contract will offset the
price change in the stocks, and the mutual fund will
have locked in the price that the stocks were selling
at in May.
Although hedging mitigates risk, it does not eliminate
all risk. For example, the relationship between the
price of the security futures contract and the price
of the underlying security traditionally tends to
remain constant over time, but it can and does vary
somewhat. Furthermore, the expiration or liquidation
of the security futures contract may not coincide with
the exact time the hedger buys or sells the underlying
stock. Therefore, hedging may not be a perfect
protection against price risk.
Risk Management
Some institutions also use futures contracts to
manage portfolio risks without necessarily intending
to change the composition of their portfolio by buying
or selling the underlying securities. The institution
does so by taking a security futures position that
is opposite to some or all of its position in the
underlying securities. This strategy involves more
risk than a traditional hedge because it is not meant
to be a substitute for an anticipated purchase or sale.
2.3. Where Security Futures 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 to joint regulation by the Securities and
Exchange Commission (SEC) and the Commodity
Futures Trading Commission (CFTC). A person holding
a position in a security futures contract who seeks
to liquidate the position must do so either on the
regulated exchange where the original trade took
place or on another regulated exchange, if any, where
a fungible security futures contract trades. (A person
may also seek to manage the risk in that position by
taking an opposite position in a comparable contract
traded on another regulated exchange.)
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Security futures contracts traded on one regulated
exchange might not be fungible with security futures
contracts traded on another regulated exchange
for a variety of reasons. Security futures traded on
different regulated exchanges may be non-fungible
because they have different contract terms (e.g., size,
settlement method), or because they are cleared
through different clearing organizations. Moreover,
a regulated exchange might not permit its security
futures contracts to be offset or liquidated by an
identical contract traded on another regulated
exchange, even though they have the same contract
terms and are cleared through the same clearing
organization. You should consult your broker about
the fungibility of the contract you are considering
purchasing or selling, including which exchange(s),
if any, on which it may be offset.
Regulated exchanges that trade security futures
contracts are required by law to establish certain
listing standards. Changes in the underlying security
of a security futures contract may, in some cases,
cause such contract to no longer meet the regulated
exchange’s listing standards. Each regulated exchange
will have rules governing the continued trading of
security futures contracts that no longer meet the
exchange’s listing standards. These rules may, for
example, permit only liquidating trades in security
futures contracts that no longer satisfy the listing
standards.
2.4. How Security Futures Differ from the
Underlying Security
Shares of common stock represent a fractional
ownership interest in the issuer of that security.
Ownership of securities confers various rights that
are not present with positions in security futures
contracts. For example, persons owning a share of
common stock may be entitled to vote in matters
affecting corporate governance. They also may be
entitled to receive dividends and corporate disclosure,
such as annual and quarterly reports.
The purchaser of a security futures contract, by
contrast, has only a contract for future delivery of
the underlying security. The purchaser of the security
futures contract is not entitled to exercise any voting
rights over the underlying security and is not entitled
to any dividends that may be paid by the issuer.
Moreover, the purchaser of a security futures contract
does not receive the corporate disclosures that are
received by shareholders of the underlying security,
although such corporate disclosures must be made
publicly available through the SEC’s EDGAR system,
which can be accessed at www.sec.gov. You should
review such disclosures before entering into a security
futures contract. See Section 8.1 for further discussion
of the impact of corporate events on a security futures
contract.
All security futures contracts are marked-to-market
at least daily, usually after the close of trading, as
described in Section 3 of this document. At that time,
the account of each buyer and seller is credited with
the amount of any gain, or debited by the amount of
any loss, on the security futures contract, based on
the contract price established at the end of the day
for settlement purposes (the “daily settlement price”).
By contrast, the purchaser or seller of the underlying
instrument does not have the profit and loss from
his or her investment credited or debited until the
position in that instrument is closed out.
Naturally, as with any financial product, the value of
the security futures contract and of the underlying
security may fluctuate. However, owning the
underlying security does not require an investor to
settle his or her profits and losses daily. By contrast,
as a result of the mark-to-market requirements
discussed above, a person who is long a security
futures contract often will be required to deposit
additional funds into his or her account as the price
of the security futures contract decreases. Similarly, a
person who is short a security futures contract often
will be required to deposit additional funds into his
or her account as the price of the security futures
contract increases.
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Another significant difference is that security futures
contracts expire on a specific date. Unlike an owner of
the underlying security, a person cannot hold a long
position in a security futures contract for an extended
period of time in the hope that the price will go up.
If you do not liquidate your security futures contract,
you will be required to settle the contract when
it expires, either through physical delivery or cash
settlement. For cash-settled contracts in particular,
upon expiration, an individual will no longer have an
economic interest in the securities underlying the
security futures contract.
2.5. Comparison to Options
Although security futures contracts share some
characteristics with options on securities (options
contracts), these products are also different in a
number of ways. Below are some of the important
distinctions between equity options contracts and
security futures contracts.
If you purchase an options contract, you have the
right, but not the obligation, to buy or sell a security
prior to the expiration date. If you sell an options
contract, you have the obligation to buy or sell a
security prior to the expiration date. By contrast, if
you have a position in a security futures contract
(either long or short), you have both the right and
the obligation to buy or sell a security at a future
date. The only way that you can avoid the obligation
incurred by the security futures contract is to liquidate
the position with an offsetting contract.
A person purchasing an options contract runs the risk
of losing the purchase price (premium) for the option
contract. Because it is a wasting asset, the purchaser
of an options contract who neither liquidates
the options contract in the secondary market nor
exercises it at or prior to expiration will necessarily
lose his or her entire investment in the options
contract. However, a purchaser of an options contract
cannot lose more than the amount of the premium.
Conversely, the seller of an options contract receives
the premium and assumes the risk that he or she will
be required to buy or sell the underlying security on
or prior to the expiration date, in which event his or
her losses may exceed the amount of the premium
received. Although the seller of an options contract
is required to deposit margin to reflect the risk of its
obligation, he or she may lose many times his or her
initial margin deposit.
By contrast, the purchaser and seller of a security
futures contract each enter into an agreement to buy
or sell a specific quantity of shares in the underlying
security. Based upon the movement in prices of the
underlying security, a person who holds a position in a
security futures contract can gain or lose many times
his or her initial margin deposit. In this respect, the
benefits of a security futures contract are similar to
the benefits of purchasing an option, while the risks
of entering into a security futures contract are similar
to the risks of selling an option.
Both the purchaser and the seller of a security futures
contract have daily margin obligations. At least once
each day, security futures contracts are marked-to-
market and the increase or decrease in the value of
the contract is credited or debited to the buyer and
the seller. As a result, any person who has an open
position in a security futures contract may be called
upon to meet additional margin requirements or may
receive a credit of available funds.
Example:
Assume that Customers A and B each anticipate
an increase in the market price of XYZ stock, which
is currently $50 a share. Customer A purchases
an XYZ 50 call (covering 100 shares of XYZ at a
premium of $5 per share). The option premium
is $500 ($5 per share X 100 shares). Customer
B purchases an XYZ security futures contract
(covering 100 shares of XYZ). The total value of
the contract is $5000 ($50 share value X 100
shares). The required margin is $1000 (or 20%
of the contract value).
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Price of XYZ
at Expiration
Customer A
Profit/Loss
Customer B
Profit/Loss
65 $1000 $1500
60 $500 $1000
55 $0 $500
50 - $500 $0
45 - $500 - $500
40 - $500 - $1000
35 - $500 - $1500
The most that Customer A can lose is $500, the option
premium. Customer A breaks even at $55 per share,
and makes money at higher prices. Customer B may
lose more than his initial margin deposit. Unlike the
options premium, the margin on a futures contract
is not a cost but a performance bond. The losses for
Customer B are not limited by this performance bond.
Rather, the losses or gains are determined by the
settlement price of the contract, as provided in the
example above. Note that if the price of XYZ falls to
$35 per share, Customer A loses only $500, whereas
Customer B loses $1500.
2.6. Components of a Security Futures Contract
Each regulated exchange can choose the terms of
the security futures contracts it lists, and those terms
may differ from exchange to exchange or contract to
contract. Some of those contract terms are discussed
below. However, you should ask your broker for a
copy of the contract specifications before trading a
particular contract.
2.6.1. Each security futures contract has a set size. The
size of a security futures contract is determined by the
regulated exchange on which the contract trades. For
example, a security futures contract for a single stock
may be based on 100 shares of that stock. If prices are
reported per share, the value of the contract would
be the price times 100. For narrow-based security
indices, the value of the contract is the price of the
component securities times the multiplier set by the
exchange as part of the contract terms.
2.6.2. Security futures contracts expire at set times
determined by the listing exchange. For example, a
particular contract may expire on a particular day,
e.g., the third Friday of the expiration month. Up
until expiration, you may liquidate an open position
by offsetting your contract with a fungible opposite
contract that expires in the same month. If you do
not liquidate an open position before it expires,
you will be required to make or take delivery of the
underlying security or to settle the contract in cash
after expiration.
2.6.3. Although security futures contracts on a
particular security or a narrow-based security index
may be listed and traded on more than one regulated
exchange, the contract specifications may not be the
same. Also, prices for contracts on the same security
or index may vary on different regulated exchanges
because of different contract specifications.
2.6.4. Prices of security futures contracts are usually
quoted the same way prices are quoted in the
underlying instrument. For example, a contract for
an individual security would be quoted in dollars and
cents per share. Contracts for indices would be quoted
by an index number, usually stated to two decimal
places.
2.6.5. Each security futures contract has a minimum
price fluctuation (called a tick), which may differ from
product to product or exchange to exchange. For
example, if a particular security futures contract has
a tick size of 1¢, you can buy the contract at $23.21 or
$23.22 but not at $23.215.
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2.7. Trading Halts
The value of your positions in security futures
contracts could be affected if trading is halted in
either the security futures contract or the underlying
security. In certain circumstances, regulated
exchanges are required by law to halt trading in
security futures contracts. For example, trading
on a particular security futures contract must be
halted if trading is halted on the listed market for
the underlying security as a result of pending news,
regulatory concerns, or market volatility. Similarly,
trading of a security futures contract on a narrow-
based security index must be halted under such
circumstances if trading is halted on securities
accounting for at least 50 percent of the market
capitalization of the index. In addition, regulated
exchanges are required to halt trading in all security
futures contracts for a specified period of time when
the Dow Jones Industrial Average (“DJIA”) experiences
one-day declines of 10-, 20- and 30-percent. The
regulated exchanges may also have discretion under
their rules to halt trading in other circumstances–
such as when the exchange determines that the halt
would be advisable in maintaining a fair and orderly
market.
A trading halt, either by a regulated exchange that
trades security futures or an exchange trading the
underlying security or instrument, could prevent
you from liquidating a position in security futures
contracts in a timely manner, which could prevent
you from liquidating a position in security futures
contracts at that time.
2.8. Trading Hours
Each regulated exchange trading a security futures
contract may open and close for trading at different
times than other regulated exchanges trading security
futures contracts or markets trading the underlying
security or securities. Trading in security futures
contracts prior to the opening or after the close of the
primary market for the underlying security may be
less liquid than trading during regular market hours.
Every regulated U.S. exchange that trades security
futures contracts is required to have a relationship
with a clearing organization that serves as the
guarantor of each security futures contract
traded on that exchange. A clearing organization
performs the following functions: matching trades;
effecting settlement and payments; guaranteeing
performance; and facilitating deliveries.
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Throughout each trading day, the clearing
organization matches trade data submitted by
clearing members on behalf of their customers or
for the clearing member’s proprietary accounts. If an
account is with a brokerage firm that is not a member
of the clearing organization, then the brokerage firm
will carry the security futures position with another
brokerage firm that is a member of the clearing
organization. Trade records that do not match, either
because of a discrepancy in the details or because
one side of the transaction is missing, are returned to
the submitting clearing members for resolution. The
members are required to resolve such “out trades”
before or on the open of trading the next morning.
When the required details of a reported transaction
have been verified, the clearing organization assumes
the legal and financial obligations of the parties to
the transaction. One way to think of the role of the
clearing organization is that it is the “buyer to every
seller and the seller to every buyer.” The insertion
or substitution of the clearing organization as the
counter-party to every transaction enables a customer
to liquidate a security futures position without
regard to what the other party to the original security
futures contract decides to do.
The clearing organization also effects the settlement
of gains and losses from security futures contracts
between clearing members. At least once each day,
clearing member brokerage firms must either pay
to, or receive from, the clearing organization the
difference between the current price and the trade
price earlier in the day, or for a position carried over
from the previous day, the difference between the
current price and the previous day’s settlement price.
Whether a clearing organization effects settlement of
gains and losses on a daily basis or more frequently
will depend on the conventions of the clearing
organization and market conditions. Because the
clearing organization assumes the legal and financial
obligations for each security futures contract, you
should expect it to ensure that payments are made
promptly to protect its obligations.
Gains and losses in security futures contracts are also
reflected in each customer’s account on at least a
daily basis. Each day’s gains and losses are determined
based on a daily settlement price disseminated by
the regulated exchange trading the security futures
contract or its clearing organization. If the daily
settlement price of a particular security futures
contract rises, the buyer has a gain and the seller a
loss. If the daily settlement price declines, the buyer
has a loss and the seller a gain. This process is known
as “marking-to-market” or daily settlement. As a
result, individual customers normally will be called on
to settle daily.
The one-day gain or loss on a security futures contract
is determined by calculating the difference between
the current day’s settlement price and the previous
day’s settlement price. For example, assume a security
futures contract is purchased at a price of $120. If the
daily settlement price is either $125 (higher) or $117
(lower), the effects would be as follows:
(1 contract representing 100 shares)
Daily Settlement
Value
Buyer’s
Account
Seller’s
Account
$125 $500 gain (credit) $500 loss (debit)
$117 $300 loss (debit) $300 gain (credit)
SECTION 3
Clearing Organizations And Mark-To-Market
Requirements
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The cumulative gain or loss on a customer’s open
security futures positions is generally referred to
as “open trade equity” and is listed as a separate
component of account equity on your customer
account statement.
A discussion of the role of the clearing organization
in effecting delivery is discussed in Section 5.
When a broker-dealer lends a customer part of the
funds needed to purchase a security such as common
stock, the term “margin” refers to the amount of cash,
or down payment, the customer is required to deposit.
By contrast, a security futures contract is an obligation
and not an asset. A security futures contract has no
value as collateral for a loan. Because of the potential
for a loss as a result of the daily marked-to-market
process, however, a margin deposit is required of each
party to a security futures contract. This required
margin deposit also is referred to as a “performance
bond.”
In the first instance, margin requirements for security
futures contracts are set by the exchange on which
the contract is traded, subject to certain minimums
set by law. The basic margin requirement is 20% of
the current value of the security futures contract,
although some strategies may have lower margin
requirements. Requests for additional margin are
known as “margin calls.” Both buyer and seller must
individually deposit the required margin to their
respective accounts.
It is important 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 firm to brokerage firm.
Furthermore, a brokerage firm can increase its
“house” margin requirements at any time without
providing advance notice, and such increases could
result in a margin call.
For example, some firms may require margin to be
deposited the business day following the day of a
deficiency, or some firms may even require deposit
on the same day. Some firms may require margin to
be on deposit in the account before they will accept
an order for a security futures contract. Additionally,
SECTION 4
Margin And Leverage
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brokerage firms may have special requirements as
to how margin calls are to be met, such as requiring
a wire transfer from a bank, or deposit of a certified
or cashier’s check. You should thoroughly read and
understand the customer agreement with your
brokerage firm before entering into any transactions
in security futures contracts.
If through the daily cash settlement process, losses in
the account of a security futures contract participant
reduce the funds on deposit (or equity) below the
maintenance margin level (or the firm’s higher
“house” requirement), the brokerage firm will require
that additional funds be deposited.
If additional margin is not deposited in accordance
with the firm’s policies, the firm can liquidate your
position in security futures contracts or sell assets in
any of your accounts at the firm to cover the margin
deficiency. You remain responsible for any shortfall in
the account after such liquidations or sales. Unless
provided otherwise in your customer agreement or by
applicable law, you are not entitled to choose which
futures contracts, other securities or other assets are
liquidated or sold to meet a margin call or to obtain
an extension of time to meet a margin call.
Brokerage firms generally reserve the right to
liquidate a customer’s security futures contract
positions or sell customer assets to meet a margin
call at any time without contacting the customer.
Brokerage firms may also enter into equivalent
but opposite positions for your account in order
to manage the risk created by a margin call. Some
customers mistakenly believe that a firm is required
to contact them for a margin call to be valid, and that
the firm is not allowed to liquidate securities or other
assets in their accounts to meet a margin call unless
the firm has contacted them first. This is not the case.
While most firms notify their customers of margin
calls and allow some time for deposit of additional
margin, they are not required to do so. Even if a firm
has notified a customer of a margin call and set a
specific due date for a margin deposit, the firm can
still take action as necessary to protect its financial
interests, including the immediate liquidation
of positions without advance notification to the
customer.
Here is an example of the margin requirements for a
long security futures position.
A customer buys 3 July EJG security futures at 71.50.
Assuming each contract represents 100 shares, the
nominal value of the position is $21,450 (71.50 x 3
contracts x 100 shares). If the initial margin rate is
20% of the nominal value, then the customer’s initial
margin requirement would be $4,290. The customer
deposits the initial margin, bringing the equity in the
account to $4,290.
First, assume that the next day the settlement price
of EJG security futures falls to 69.25. The marked-to-
market loss in the customer’s equity is $675 (71.50
– 69.25 x 3 contacts x 100 shares). The customer’s
equity decreases to $3,615 ($4,290 – $675). The new
nominal value of the contract is $20,775 (69.25 x 3
contracts x 100 shares). If the maintenance margin
rate is 20% of the nominal value, then the customer’s
maintenance margin requirement would be $4,155.
Because the customer’s equity had decreased to
$3,615 (see above), the customer would be required to
have an additional $540 in margin ($4,155 – $3,615).
Alternatively, assume that the next day the
settlement price of EJG security futures rises to 75.00.
The mark-to-market gain in the customer’s equity
is $1,050 (75.00 – 71.50 x 3 contacts x 100 shares).
The customer’s equity increases to $5,340 ($4,290 +
$1,050). The new nominal 33 value of the contract
is $22,500 (75.00 x 3 contracts x 100 shares). If the
maintenance margin rate is 20% of the nominal
value, then the customer’s maintenance margin
requirement would be $4,500. Because the customer’s
equity had increased to $5,340 (see above), the
customer’s excess equity would be $840.
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The process is exactly the same for a short position,
except that margin calls are generated as the
settlement price rises rather than as it falls. This
is because the customer’s equity decreases as the
settlement price rises and increases as the settlement
price falls.
Because the margin deposit required to open a
security futures position is a fraction of the nominal
value of the contracts being purchased or sold,
security futures contracts are said to be highly
leveraged. The smaller the margin requirement in
relation to the underlying value of the security futures
contract, the greater the leverage. Leverage allows
exposure to a given quantity of an underlying asset
for a fraction of the investment needed to purchase
that quantity outright. In sum, buying (or selling) a
security futures contract provides the same dollar and
cents profit and loss outcomes as owning (or shorting)
the underlying security. However, as a percentage of
the margin deposit, the potential immediate exposure
to profit or loss is much higher with a security futures
contract than with the underlying security.
For example, if a security futures contract is
established at a price of $50, the contract has a
nominal value of $5,000 (assuming the contract is for
100 shares of stock). The margin requirement may be
as low as 20%. In the example just used, assume the
contract price rises from $50 to $52 (a $200 increase
in the nominal value). This represents a $200 profit to
the buyer of the security futures contract, and a 20%
return on the $1,000 deposited as margin. The reverse
would be true if the contract price decreased from
$50 to $48. This represents a $200 loss to the buyer,
or 20% of the $1,000 deposited as margin. Thus,
leverage can either benefit or harm an investor.
Note that a 4% decrease in the value of the contract
resulted in a loss of 20% of the margin deposited. A
20% decrease would wipe out 100% of the margin
deposited on the security futures contract.
If you do not liquidate your position prior to the end
of trading on the last day before the expiration of the
security futures contract, you are obligated to either
1) make or accept a cash payment (“cash settlement”)
or 2) deliver or accept delivery of the underlying
securities in exchange for final payment of the final
settlement price (“physical delivery”). The terms of
the contract dictate whether it is settled through
cash settlement or by physical delivery.
The expiration of a security futures contract is
established by the exchange on which the contract
is listed. On the expiration day, security futures
contracts cease to exist. Typically, the last trading day
of a security futures contract will be the third Friday
of the expiring contract month, and the expiration
day will be the following Saturday. This follows the
expiration conventions for stock options and broad-
based stock indexes. Please keep in mind that the
expiration day is set by the listing exchange and may
deviate from these norms.
5.1. Cash Settlement
In the case of cash settlement, no actual securities
are delivered at the expiration of the security
futures contract. Instead, you must settle any open
positions in security futures by making or receiving
a cash payment based on the difference between
the final settlement price and the previous day’s
settlement price. Under normal circumstances, the
final settlement price for a cash-settled contract will
reflect the opening price for the underlying security.
SECTION 5
Settlement
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Once this payment is made, neither the buyer nor the
seller of the security futures contract has any further
obligations on the contract.
5.2. Settlement by Physical Delivery
Settlement by physical delivery is carried out by
clearing brokers or their agents with National
Securities Clearing Corporation (NSCC), an SEC-
regulated securities clearing agency. Such settlements
are made in much the same way as they are for
purchases and sales of the underlying security.
Promptly after the last day of trading, the regulated
exchange’s clearing organization will report a
purchase and sale of the underlying stock at the
previous day’s settlement price (also referred to as the
“invoice price”) to NSCC. If NSCC does not reject the
transaction by a time specified in its rules, settlement
is effected pursuant to the rules of NSCC within the
normal clearance and settlement cycle for securities
transactions, which currently is three business days.
If you hold a short position in a physically settled
security futures contract to expiration, you will be
required to make delivery of the underlying securities.
If you already own the securities, you may tender
them to your brokerage firm. If you do not own the
securities, you will be obligated to purchase them.
Some brokerage firms may not be able to purchase
the securities for you. If your brokerage firm cannot
purchase the underlying securities on your behalf
to fulfill a settlement obligation, you will have to
purchase the securities through a different firm.
Positions in security futures contracts may be held
either in a securities account or in a futures account.
Your brokerage firm may or may not permit you to
choose the types of account in which your positions in
security futures contracts will be held. The protections
for funds deposited or earned by customers in
connection with trading in security futures contracts
differ depending on whether the positions are carried
in a securities account or a futures account. If your
positions are carried in a securities account, you
will not receive the protections available for futures
accounts. Similarly, if your positions are carried in a
futures account, you will not receive the protections
available for securities accounts. You should ask your
broker which of these protections will apply to your
funds.
You should be aware that the regulatory protections
applicable to your account are not intended to insure
you against losses you may incur as a result of a
decline or increase in the price of a security futures
contract. As with all financial products, you are solely
responsible for any market losses in your account.
Your brokerage firm must tell you whether your
security futures positions will be held in a securities
account or a futures account. If your brokerage firm
gives you a choice, it must tell you what you have to
do to make the choice and which type of account will
be used if you fail to do so. You should understand
that certain regulatory protections for your account
will depend on whether it is a securities account or a
futures account.
SECTION 6
Customer Account Protections
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6.1. Protections for Securities Accounts
If your positions in security futures contracts are
carried in a securities account, they are covered by
SEC rules governing the safeguarding of customer
funds and securities. These rules prohibit a broker/
dealer from using customer funds and securities to
finance its business. As a result, the broker/dealer is
required to set aside funds equal to the net of all its
excess payables to customers over receivables from
customers. The rules also require a broker/dealer to
segregate all customer fully paid and excess margin
securities carried by the broker/dealer for customers.
The Securities Investor Protection Corporation (SIPC)
also covers positions held in securities accounts.
SIPC was created in 1970 as a nonprofit, non-
government, membership corporation, funded by
member broker/dealers. Its primary role is to return
funds and securities to customers if the broker/
dealer holding these assets becomes insolvent. SIPC
coverage applies to customers of current (and in
some cases former) SIPC members. Most broker/
dealers registered with the SEC are SIPC members;
those few that are not must disclose this fact to their
customers. SIPC members must display an official
sign showing their membership. To check whether
a firm is a SIPC member, go to www.sipc.org, call the
SIPC Membership Department at (202) 371-8300, or
write to SIPC Membership Department, Securities
Investor Protection Corporation, 805 Fifteenth Street,
NW, Suite 800, Washington, DC 20005-2215.
SIPC coverage is limited to $500,000 per customer,
including up to $100,000 for cash. For example, if
a customer has 1,000 shares of XYZ stock valued at
$200,000 and $10,000 cash in the account, both the
security and the cash balance would be protected.
However, if the customer has shares of stock valued
at $500,000 and $100,000 in cash, only a total of
$500,000 of those assets will be protected.
For purposes of SIPC coverage, customers are persons
who have securities or cash on deposit with a SIPC
member for the purpose of, or as a result of, securities
transactions. SIPC does not protect customer funds
placed with a broker/ dealer just to earn interest.
Insiders of the broker/ dealer, such as its owners,
officers, and partners, are not customers for purposes
of SIPC coverage.
6.2. Protections for Futures Accounts
If your security futures positions are carried in a
futures account, they must be segregated from the
brokerage firm’s own funds and cannot be borrowed
or otherwise used for the firm’s own purposes. If
the funds are deposited with another entity ( e.g., a
bank, clearing broker, or clearing organization), that
entity must acknowledge that the funds belong to
customers and cannot be used to satisfy the firm’s
debts. Moreover, although a brokerage firm may carry
funds belonging to different customers in the same
bank or clearing account, it may not use the funds of
one customer to margin or guarantee the transactions
of another customer. As a result, the brokerage firm
must add its own funds to its customers’ segregated
funds to cover customer debits and deficits. Brokerage
firms must calculate their segregation requirements
daily.
You may not be able to recover the full amount of
any funds in your account if the brokerage firm
becomes insolvent and has insufficient funds to
cover its obligations to all of its customers. However,
customers with funds in segregation receive
priority in bankruptcy proceedings. Furthermore, all
customers whose funds are required to be segregated
have the same priority in bankruptcy, and there is
no ceiling on the amount of funds that must be
segregated for or can be recovered by a particular
customer.
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Your brokerage firm is also required to separately
maintain funds invested in security futures contracts
traded on a foreign exchange. However, these funds
may not receive the same protections once they are
transferred to a foreign entity ( e.g., a foreign broker,
exchange or clearing organization) to satisfy margin
requirements for those products. You should ask your
broker about the bankruptcy protections available
in the country where the foreign exchange (or other
entity holding the funds) is located.
Certain traders who pursue a day trading strategy
may seek to use security futures contracts as part
of their trading activity. Whether day trading in
security futures contracts or other securities, investors
engaging in a day trading strategy face a number of
risks.
Day trading in security futures contracts requires
in-depth knowledge of the securities and futures
markets and of trading techniques and strategies.
In attempting to profit through day trading, you
will compete with professional traders who are
knowledgeable and sophisticated in these markets.
You should have appropriate experience before
engaging in day trading.
Day trading in security futures contracts can result
in substantial commission charges, even if the per
trade cost is low. The more trades you make, the
higher your total commissions will be. The total
commissions you pay will add to your losses and
reduce your profits. For instance, assuming that
a round-turn trade costs $16 and you execute an
average of 29 round-turn transactions per day each
trading day, you would need to generate an annual
profit of $111,360 just to cover your commission
expenses.
Day trading can be extremely risky. Day trading
generally is not appropriate for someone of limited
resources and limited investment or trading
experience and low risk tolerance. You should be
prepared to lose all of the funds that you use for
day trading. In particular, you should not fund day
trading activities with funds that you cannot afford
to lose.
SECTION 7
Special Risks For Day Traders
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8.1. Corporate Events
As noted in Section 2.4, an equity security represents
a fractional ownership interest in the issuer of that
security. By contrast, the purchaser of a security
futures contract has only a contract for future
delivery of the underlying security. Treatment of
dividends and other corporate events affecting the
underlying security may be reflected in the security
futures contract depending on the applicable clearing
organization rules. Consequently, individuals should
consider how dividends and other developments
affecting security futures in which they transact will
be handled by the relevant exchange and clearing
organization. The specific adjustments to the terms
of a security futures contract are governed by the
rules of the applicable clearing organization. Below
is a discussion of some of the more common types of
adjustments that you may need to consider.
Corporate issuers occasionally announce stock splits.
As a result of these splits, owners of the issuer’s
common stock may own more shares of the stock,
or fewer shares in the case of a reverse stock split.
The treatment of stock splits for persons owning a
security futures contract may vary according to the
terms of the security futures contract and the rules
of the clearing organization. For example, the terms
of the contract may provide for an adjustment in
the number of contracts held by each party with a
long or short position in a security future, or for an
adjustment in the number of shares or units of the
instrument underlying each contract, or both.
Corporate issuers also occasionally issue special
dividends. A special dividend is an announced
cash dividend payment outside the normal and
customary practice of a corporation. The terms of a
security futures contract may be adjusted for special
dividends. The adjustments, if any, will be based upon
the rules of the exchange and clearing organization.
In general, there will be no adjustments for ordinary
dividends as they are recognized as a normal and
customary practice of an issuer and are already
accounted for in the pricing of security futures.
Corporate issuers occasionally may be involved in
mergers and acquisitions. Such events may cause
the underlying security of a security futures contact
to change over the contract duration. The terms of
security futures contracts may also be adjusted to
reflect other corporate events affecting the underlying
security.
8.2. Position Limits and Large Trader Reporting
All security futures contracts trading on regulated
exchanges in the United States are subject to position
limits or position accountability limits. Position limits
restrict the number of security futures contracts that
any one person or group of related persons may hold
or control in a particular security futures contract.
In contrast, position accountability limits permit
the accumulation of positions in excess of the limit
without a prior exemption. In general, position limits
and position accountability limits are beyond the
thresholds of most retail investors. Whether a security
futures contract is subject to position limits, and the
level for such limits, depends upon the trading activity
and market capitalization of the underlying security
of the security futures contract.
SECTION 8
Other
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Position limits apply are required for security futures
contracts that overlie a security that has an average
daily trading volume of 20 million shares or fewer.
In the case of a security futures contract overlying a
security index, position limits are required if any one
of the securities in the index has an average daily
trading volume of 20 million shares or fewer. Position
limits also apply only to an expiring security futures
contract during its last five trading days. A regulated
exchange must establish position limits on security
futures that are no greater than 13,500 (100 share)
contracts, unless the underlying security meets
certain volume and shares outstanding thresholds,
in which case the limit may be increased to 22,500
(100 share) contracts.
For security futures contracts overlying a security
or securities with an average trading volume of
more than 20 million shares, regulated exchanges
may adopt position accountability rules. Under
position accountability rules, a trader holding a
position in a security futures contract that exceeds
22,500 contracts (or such lower limit established
by an exchange) must agree to provide information
regarding the position and consent to halt increasing
that position if requested by the exchange.
Brokerage firms must also report large open positions
held by one person (or by several persons acting
together) to the CFTC as well as to the exchange on
which the positions are held. The CFTC’s reporting
requirements are 1,000 contracts for security futures
positions on individual equity securities and 200
contracts for positions on a narrow-based index.
However, individual exchanges may require the
reporting of large open positions at levels less than
the levels required by the CFTC. In addition, brokerage
firms must submit identifying information on the
account holding the reportable position (on a form
referred to as either an “Identification of Special
Accounts Form” or a “Form 102”) to the CFTC and to
the exchange on which the reportable position exists
within three business days of when a reportable
position is first established.
8.3. Transactions on Foreign Exchanges
U.S. customers may not trade security futures on
foreign exchanges until authorized by U.S. regulatory
authorities. U.S. regulatory authorities do not regulate
the activities of foreign exchanges and may not,
on their own, compel enforcement of the rules of a
foreign exchange or the laws of a foreign country.
While U.S. law governs transactions in security futures
contracts that are effected in the U.S., regardless of
the exchange on which the contracts are listed, the
laws and rules governing transactions on foreign
exchanges vary depending on the country in which
the exchange is located.
8.4. Tax Consequences
For most taxpayers, security futures contracts are
not treated like other futures contracts. Instead, the
tax consequences of a security futures transaction
depend on the status of the taxpayer and the type
of position (e.g., long or short, covered or uncovered).
Because of the importance of tax considerations
to transactions in security futures, readers should
consult their tax advisors as to the tax consequences
of these transactions.
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This glossary is intended to assist customers in
understanding specialized terms used in the futures
and securities industries. It is not inclusive and is not
intended to state or suggest the legal significance or
meaning of any word or term.
Arbitrage
Taking an economically opposite position in a security
futures contract on another exchange, in an options
contract, or in the underlying security.
Broad-based security index
A security index that does not fall within the statutory
definition of a narrow-based security index (see
Narrow-based security index). A future on a broad-
based security index is not a security future. This
risk disclosure statement applies solely to security
futures and generally does not pertain to futures on a
broad-based security index. Futures on a broad-based
security index are under exclusive jurisdiction of
the CFTC.
Cash settlement
A method of settling certain futures contracts by
having the buyer (or long) pay the seller (or short) the
cash value of the contract according to a procedure
set by the exchange.
Clearing broker
A member of the clearing organization for the
contract being traded. All trades, and the daily profits
or losses from those trades, must go through a
clearing broker.
Clearing organization
A regulated entity that is responsible for settling
trades, collecting losses and distributing profits,
and handling deliveries.
Contract
1. the unit of trading for a particular futures contract
(e.g., one contract may be 100 shares of the
underlying security);
2. the type of future being traded (e.g., futures on
ABC stock).
Contract month
The last month in which delivery is made against
the futures contract or the contract is cash-settled.
Sometimes referred to as the delivery month.
Day trading strategy
An overall trading strategy characterized by the
regular transmission by a customer of intra-day orders
to effect both purchase and sale transactions in the
same security or securities.
EDGAR
The SEC’s Electronic Data Gathering, Analysis, and
Retrieval system maintains electronic copies of
corporate information filed with the agency. EDGAR
submissions may be accessed through the SEC’s
Web Site, www.sec.gov.
SECTION 9
Glossary Of Terms
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Futures contract
A futures contract is:
1. an agreement to purchase or sell a commodity
for delivery in the future;
2. at a price determined at initiation of the contract;
3. that obligates each party to the contract to fulfill
it at the specified price;
4. that is used to assume or shift risk; and
5. that may be satisfied by delivery or offset.
Hedging
The purchase or sale of a security future to reduce or
offset the risk of a position in the underlying security
or group of securities (or a close economic equivalent).
Illiquid market
A market (or contract) with few buyers and/or sellers.
Illiquid markets have little trading activity and those
trades that do occur may be done at large price
increments.
Liquidation
Entering into an offsetting transaction. Selling a
contract that was previously purchased liquidates a
futures position in exactly the same way that selling
100 shares of a particular stock liquidates an earlier
purchase of the same stock. Similarly, a futures
contract that was initially sold can be liquidated by
an offsetting purchase.
Liquid market
A market (or contract) with numerous buyers and
sellers trading at small price increments.
Long
1. the buying side of an open futures contact;
2. a person who has bought futures contracts that
are still open.
Margin
The amount of money that must be deposited by
both buyers and sellers to ensure performance of
the person’s obligations under a futures contract.
Margin on security futures contracts is a performance
bond rather than a down payment for the underlying
securities.
Mark-to-market
To debit or credit accounts daily to reflect that day’s
profits and losses.
Narrow-based security index
In general, and subject to certain exclusions, 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 comprises
more than 30% of its weighting;
3. the five highest weighted component securities
together comprise more than 60% of its weighting;
or
4. the lowest weighted component securities
comprising, in the aggregate, 25% of the index’s
weighting have an aggregate dollar value of
average daily trading volume of less than $50
million (or in the case of an index with 15 or
more component securities, $30 million).
A security index that is not narrow-based is a
“broad based security index.” (See Broad-based
security index).
Nominal value
The face value of the futures contract, obtained by
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 $5025.00.
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Offsetting
Liquidating open positions by either selling fungible
contracts in the same contract month as an open long
position or buying fungible contracts in the same
contract month as an open short position.
Open interest
The total number of open long (or short) contracts in
a particular contract month. Open position – a futures
contract position that has neither been offset nor
closed by cash settlement or physical delivery.
Performance bond
Another way to describe margin payments for
futures contracts, which are good faith deposits to
ensure performance of a person’s obligations under a
futures contract rather than down payments for the
underlying securities.
Physical delivery
The tender and receipt of the actual security
underlying the security futures contract in exchange
for payment of the final settlement price.
Position
A person’s net long or short open contracts.
Regulated exchange
A registered national securities exchange, a national
securities association registered under Section 15A(a)
of the Securities Exchange Act of 1934, a designated
contract market, a registered derivatives transaction
execution facility, or an alternative trading system
registered as a broker or dealer.
Security futures contract
A legally binding agreement between two parties
to purchase or sell in the future a specific quantify
of shares of a security (such as common stock, an
exchange-traded fund, or ADR) or a narrow-based
security index, at a specified price.
Settlement price
1. the daily price that the clearing organization uses
to mark open positions to market for determining
profit and loss and margin calls,
2. the price at which open cash settlement contracts
are settled on the last trading day and open
physical delivery contracts are invoiced for delivery.
Short
1. the selling side of an open futures contract,
2. a person who has sold futures contracts that are
still open.
Speculating
Buying and selling futures contracts with the hope
of profiting from anticipated price movements.
Spread
1. holding a long position in one futures contract
and a short position in a related futures contract
or contract month in order to profit from an
anticipated change in the price relationship
between the two,
2. the price difference between two contracts or
contract months.
Stop limit order
An order that becomes a limit order when the market
trades at a specified price. The order can only be filled
at the stop limit price or better.
Stop loss order
An order that becomes a market order when the
market trades at a specified price. The order will
be filled at whatever price the market is trading at.
Also called a stop order.
Tick
The smallest price change allowed in a particular
contract.
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Trader
A professional speculator who trades for his or her
own account.
Underlying security
The instrument on which the security futures contract
is based. This instrument can be an individual equity
security (including common stock and certain
exchange-traded funds and American Depositary
Receipts) or a narrow-based index.
Volume
The number of contracts bought or sold during
a specified period of time. This figure includes
liquidating transactions.
August 2010
Supplement To The Security Futures Risk
Disclosure Statement
The October 2002 Security Futures Risk Disclosure
Statement is amended as provided below.
The first full paragraph on page 46, which pertains to
dividends, is replaced with the following paragraph:
Corporate issuers also occasionally issue special
dividends. A special dividend is an announced
cash dividend payment outside the normal and
customary practice of a corporation. The terms
of a security futures contract may be adjusted
for special dividends. The adjustments, if any,
will be based upon the rules of the exchange and
clearing organization. In general, there will be no
adjustments for ordinary dividends as they are a
normal and customary practice of an issuer and
are already accounted for in the pricing of security
futures. However, adjustments for ordinary
dividends may be made for a specified class of
security futures contracts based on the rules of the
exchange and the clearing organization.
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The October 2002 Security Futures Risk Disclosure
Statement is amended as provided below.
The first paragraph under Section 5.2. Settlement
by Physical Delivery is replaced with the following
paragraph:
Settlement by physical delivery is carried out by
clearing brokers or their agents with National
Securities Clearing Corporation (NSCC), an
SEC-regulated securities clearing agency. Such
settlements are made in much the same way as
they are for purchases and sales of the underlying
security. Promptly after the last day of trading,
the regulated exchange’s clearing organization
will report a purchase and sale of the underlying
stock at the previous day’s settlement price (also
referred to as the “invoice price”) to NSCC. In
general, if NSCC does not reject the transaction by
a time specified in its rules, settlement is effected
pursuant to the rules of the exchange and NSCC’s
Rules and Procedures within the normal clearance
and settlement cycle for securities transactions,
which currently is three business days. However,
settlement may be effected on a shorter time-
frame based on the rules of the exchange and
subject to NSCC’s Rules and Procedures.
April 2014
Supplement To The Security Futures Risk
Disclosure Statement
Investor protection. Market integrity.
1735 K Street, NW
Washington, DC 20006-1506
www.finra.org
© 2016 FINRA. All rights reserved.
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