index futures - pricing

[scriabinop23]

newbie questions: since buyer and seller trade a future, how is the future ACTUALLY mapped to the respective index? I'm looking for inner workings, but not a referral to a book - I just want a basic explanation, or a confirmation if my understanding is correct. Thanks.


ie:
1) ES futures must correspond to S&P price well enough, otherwise arb opportunity existed. Who,how,and what ACTUALLY does the process entail? I assume it is the exchange, ie CME that upon final delivery of the future buys or sells the underlying basket to come up with money for delivery to the future holder or seller. Correct?

2) how does this work with things that are set up to arbitrary indexes, ie housing futures? Lets say I sell a future for San diego 07. Then Schiller releases an index 10% down. Since the 'underlying' (the Schiller index) is not an actual asset, how does the actual bid/ask of the future stay correlated to the index? I assume CME can't just force this correlation. There doesn't appear to be any arb opportunity here to correct price differences between index and actual trading contract. Am I correct? What forces bid/ask to purely reflect the index price ? (again, I assume nothing if no arb is actually possible since the underlying index value is not a tradeable asset).

 

[nazzdack]

(1) Regarding the "cash settlement" of the S&P-500 contracts, the clearing house credits the remaining profitable position holders via the realized and unrealized losses from the losing position holders. (2) Regarding the real estate contracts, one way to "protect" yourself is to have a wide bid-ask spread. The spread in the eMini S&P is "tight", usually one tick or one quarter of a handle. The real estate contracts could be several handles wide; i.e. 250 bid, at 255. That gives you a better margin of safety. You could develop a rough idea of what the cash index is by closely monitoring home sales for the contract and adjusting your bids and offers based on that or the underlying paper flow and resting orders in the market.

 

[ImamicPH]

Quote from scriabinop23:


1) ES futures must correspond to S&P price well enough, otherwise arb opportunity existed. Who,how,and what ACTUALLY does the process entail? I assume it is the exchange, ie CME that upon final delivery of the future buys or sells the underlying basket to come up with money for delivery to the future holder or seller. Correct?

The future contracts are not "linked" to the underlying stocks. Any two traders just agree on a price and are responsible to each other for the difference at some date in the future, unless one party buys/sells their side of the contract before the agreed upon date.

They mirror each other in price b/c of arbing and common sense. There are offices dedicated to arbing of indexes. These people are actually buying and selling the underlying securities. The exchanges clear each side of the futures contract and are not involved in the equity side.

 

[scriabinop23]

Quote from ImamicPH:

The future contracts are not "linked" to the underlying stocks. Any two traders just agree on a price and are responsible to each other for the difference at some date in the future, unless one party buys/sells their side of the contract before the agreed upon date.

They mirror each other in price b/c of arbing and common sense. There are offices dedicated to arbing of indexes. These people are actually buying and selling the underlying securities. The exchanges clear each side of the futures contract and are not involved in the equity side.

that doesn't make any sense to-- arbing couldn't work if there's no absolute guarantee that the futures are somehow backed by something.

 

[ImamicPH]

Quote from scriabinop23:

that doesn't make any sense to-- arbing couldn't work if there's no absolute guarantee that the futures are somehow backed by something.

So what are you thinking? Everytime a customer walks into the pit, some exchange operator has to buy a basket of stocks matching the SP500. No way!!

All contracts traded are backed by the Clearing Members of that exchange!

Do you think there's tonnes of sugar sitting around the NYBOT?

 

[scriabinop23]

its makes sense now...

money payed from winners just goes to losers, and the exchange 'enforces' that agreement.

So if the market is plummetting to 0, sellers of futures contracts have a hard time getting fair value if there are no bidders, correct?

ps - edited message - made a post where i still assumed triple witching actually has something to do with cash settled index futures and their underlying movement. Why is there a correlation if the exchanges move independent? Is it merely the arbs getting rid of their baskets?

 

[ImamicPH]

Quote from scriabinop23:


So if the market is plummetting to 0, sellers of futures contracts have a hard time getting fair value if there are no bidders, correct?

ps - edited message - made a post where i still assumed triple witching actually has something to do with cash settled index futures and their underlying movement. Why is there a correlation if the exchanges move independent? Is it merely the arbs getting rid of their baskets?

The first part:

The actual index will never "fall" to zero. We're talking about 500 of the biggest companies. It's pretty diversified.
If the futures get out of line, the computers come in and balance it out.

second part:
triple witching is an entirely different beast. A lot of it has to do with options as the name implies.
As far as rolling over the SP future positions and that moving out of line with the underlying equities. Think of it like the line of a bank. If one window closes then everyone has to file in to a different line. Its hard to keep track of everyone's place.