Solving the Mystery of Stock Futures

From 1981 until 2000, futures contracts on single stocks and on small-stock indexes were prohibited under a U.S. federal law known popularly as the “Shad–Johnson Accord.” After 2002, trading was conducted on two newly formed markets; one has already closed, but the other battles on. In this article, one of the Accord's namesakes discusses why these products were banned and why they have struggled since being launched. Futures contracts on single stocks and on small-stock indexes were banned by U.S. federal law in 1981 because the Commodity Futures Trading Commission (CFTC), which enjoyed exclusive regulatory jurisdiction over all futures trading (regardless of the underlying asset), refused to cede any co-regulatory role to the SEC. The commission feared that this step would embolden other federal and state regulators to demand equal rights with respect to futures on “their” industries' assets (such as co-regulation of crude oil futures by the Federal Energy Regulatory Commission).In 2000, the CFTC changed its mind and the U.S. Congress created a system of co-regulation with the SEC of futures on single stocks and on small-stock indexes. In late 2002, two newly formed markets (joint ventures of other markets) launched the products. One market has already closed its doors; the other struggles on under new management.Some causes for the disappointing performance of these products can be readily identified. The CFTC/SEC regulatory regime is a harsh one, with margins, taxes, and transaction costs much higher than for other futures contracts and with severe restrictions on what stocks qualify. Most of these impediments are avoidable by many investors, however, especially institutional investors, which are free to bypass the regulated exchanges and to negotiate among themselves on whatever terms they wish. Even so, little evidence exists that this alternative is being used to trade these stock futures. Why? I pose several possibilities while recognizing that more study is needed.