more time to seek out balancing bids and offers, and it has greatly mod-
erated the movements in stock prices on triple witching dates.MARGIN AND LEVERAGE
One of the reasons for the popularity of futures contracts is that the cash
needed to enter into the trade is a very small part of the value of the con-
tract. Unlike stocks, there is no money that transfers between the buyer
and seller when a futures contract is bought or sold. A small amount of
good-faith collateral, or margin, is required by the broker from both the
buyer and seller to ensure that both parties will honor the contract at set-
tlement. For the S&P 500 Index, the current initial margin is about 5 per-
cent of the value of the contract. This margin can be kept in Treasury bills
with interest accruing to the investor, so trading a futures contract in-
volves neither a transfer of cash nor a loss of interest income.
Theleverage, or the amount of stock that you control relative to the
amount of margin you have to put down with a futures contract, is enor-
mous. For every dollar of cash (or Treasury bills) that you put in margin
against an S&P futures contract, you command about $20 of stock. And
forday trading, when you close your positions by the end of the day, the
margin requirements are significantly less. These low margins contrast
with the 50 percent margin requirement for the purchase of individual
stocks that has prevailed since 1974.
This ability to control $20 or more of stock with $1 of cash is remi-
niscent of the rampant speculation that existed in the 1920s before the es-
tablishment of minimum stock margin requirements. In the 1920s,
individual stocks were frequently purchased with a 10 percent margin.
It was popular to speculate with such borrowed money, for as long as
the market was rising, few investors lost money. But if the market
dropped precipitously, margin buyers often found that not only did they
lose their equity but they were also indebted to the brokerage firm. Buy-
ing futures contracts with low margins can result in similar repercus-
sions today. The tendency of low margins to fuel market volatility is
discussed in Chapter 16.USING ETFs OR FUTURES
The use of ETFs or index futures greatly increases an investor’s flexibil-
ity to manage portfolios. Suppose an investor has built up gains in indi-
vidual stocks but is now getting nervous about the market. Selling one’s
individual stocks may trigger a large tax liability.CHAPTER 15 The Rise of Exchange-Traded Funds, Stock Index Futures, and Options 261