If the S&P 500 is a weighted average of the top 500 companies, what happens if large hedge funds or investors buy or sell this particular contract in big volume? They will definitely move its price, so then how can the contract be said to follow these 500 companies?
How does the S&P futures contract follow the top 500 companies?
- Thread starter Pluralsight
- Start date
Computers!
But seriously, somebody trades every stock on the SP500 as part of an arbitrage strategy called program trading.
It was big in the 1980's and keeps everything in line. The correlations are so tight that you won't even be able to put a penny between your butt cheeks. Don't worry about it.
Your mind is in the right area for finding relative value though.
But seriously, somebody trades every stock on the SP500 as part of an arbitrage strategy called program trading.
It was big in the 1980's and keeps everything in line. The correlations are so tight that you won't even be able to put a penny between your butt cheeks. Don't worry about it.
Your mind is in the right area for finding relative value though.
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Who is zooming who? If a large futures sell drove the contract price down and created a large spread vs the cash index and you were a fast computer would you buy the futures or sell the cash? Or both? It's not written in stone what the spread should be, but it has to be close to the long bond. A big hit/positive announcement on AAPL and a hedge fund buying/selling the futures and maybe a jittery bond market and you have yourself several milliseconds of pure gut trading opportunity while the computers sort it all out (if you have a fast connection.)
Not in stone, but it is well-documented. It is called a "fair value" calculation. The interest rate most appropriate would be the corresponding government treasury with a similar life span to the futures contract.
That pure gut trading opportunity will not compensate your average trader. The institutional algos have a very strong handle on fair value and have the wherewithal to keep those inline. Taking advantage of the convergence will have a high% win rate, but the excess beta risk that you keep taking will eventually produce a blow out when a stock steamrolls over you.
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Everything corresponds to the long bond, chicken or egg, which comes first t bill or long bond? That pure gut millisecond will never be even recognized realtime by any human trader, but a computer programmed to trade like an average trader might hit it by accident.
The only non-fixed component affecting the S&P500 future vs the index is upcoming dividends.
The future is nothing more than Spot Index + interest component - dividends...
So yes, there is a bit of elasticity, but that's easily arbitraged by HFT etc through the EFP (exchange for physical) and just the index-basket....
You are right though, in saying that either one could move first. Usually in large market moves, like just now with Syria, is the future that moves first (also of course because the cash market is closed) and underlyings follow. Futures are a quick and easy way to long/short the market.... also it's liquidity is larger than the underlying index components.
But if say, a large company in an index moves big on company specific news... that will probably lead the future up or down.
More noticable in a smaller index like dj vs ym. One stupid stock can mess the whole deal up. Will they go the way of the one stock or will the one stock come back to the average. And I thought if I owned 30 stocks I would be protected from stock specific risk. Oh well, I'll try 500 and see if that works.
I've read the replies here but I still don't quite get it because I am retarded.
Wish it was simple, but funny that I trade it but I don't understand how it fully works. Maybe a little sad.
I'm still not sure which comes first, the chicken or the egg.
ok, the cash is the cash, it can only be one price based on a computation and the current price of all the stocks in the index combined, no doubt about it that's the price. If a large fund or every small investor sell their stock the price of the index must go down. The futures however can deviate from their fair value which is the price of the index plus time remaining until dividend, because they are just a bet on the cash. So a heavy hedge could drive the futures lower but would not affect the cash but the deviation is so efficient that the computers just automatically adjust the portfolio. So for all intents and purposes they are one and the same but not identical. This is common in all futures markets and their corresponding cash markets. Like corn can be 40 cents higher in a cash market than the futures but that is corn today as opposed to corn at delivery date, add in costs and you have to be pretty slick to arbitrage, but yes, the futures can and always do deviate from the cash and the deviation should reduce or narrow as the futures expiration draws near.