Index Spread Traders

[qlai]

@Real Money, moved your reply to this thread where I think it belongs. Trying to solve the puzzle ...

"The HFT firms are performing arbitrage with ES, NQ,YM, and RTY against the underlying stocks, as well as synthetic portfolios that approximate the performance of these indexes.

This arbitrage uses colocation and program trading. The secret part is that some very smart people with deep pockets see this as an opportunity.

Who is on the other side of this trade? In other words, who is willing to give an arb to HFT firms? The answer will give you an edge."

NQ/YM is a scalpers dream come true. Heavy institutional participation in this spread. Tilt the spread either direction or balance it

What you are trading with these spreads is actually sector rotation - that is, capital flows between tech and broad markets; between big caps and mid caps; that type of thing.

 

[bone]

@Real Money, moved your reply to this thread where I think it belongs. Trying to solve the puzzle ...

"The HFT firms are performing arbitrage with ES, NQ,YM, and RTY against the underlying stocks, as well as synthetic portfolios that approximate the performance of these indexes.

This arbitrage uses colocation and program trading. The secret part is that some very smart people with deep pockets see this as an opportunity.

Who is on the other side of this trade? In other words, who is willing to give an arb to HFT firms? The answer will give you an edge."

Arbitragers are taking or making liquidity from other market participants that have other objectives - like hedging or flat price speculators. If you’ve traded exchange cleared futures - you’ve traded with arbitragers.

 

[qlai]

who is willing to give an arb to HFT firms?

If we are looking purely at Index vs. its constituents (or equivalent basket), how do I know which will be used to bring the two inline? Or is that being coordinated by the "other participants" at the start?

 

[bone]

If we are looking purely at Index vs. its constituents (or equivalent basket), how do I know which will be used to bring the two inline? Or is that being coordinated by the "other participants" at the start?

It is the calculated fair value of the SPREAD between these instruments that dictates buying or selling - one doesn’t necessarily lead the other as a rule.

 

[qlai]

Well, theoretically, the constituents are supposed to dictate where the index is, so futures need to be bought or sold to reflect the change. But in reality I think Futures lead and stocks catch up.
But I can't say I have found anything tradable there yet.

 

[Overnight]

Well, theoretically, the constituents are supposed to dictate where the index is, so futures need to be bought or sold to reflect the change. But in reality I think Futures lead and stocks catch up.
But I can't say I have found anything tradable there yet.

I do not see how this can be possible. When the underlying is trading, it should move the index. When RTH AND ETH underlying is closed, then what happens? It would be the futures determining the price of the next ETH pre-open? Hmmm.

 

[Real Money]

If we are looking purely at Index vs. its constituents (or equivalent basket), how do I know which will be used to bring the two inline?

I want to say that Bone probably knows more about this than me. I really do respect him because he is one of the few members on this forum that is careful, thoughtful, and intelligent. His advise and comments helped me find an edge.

So for your question.

HFT CASH AND CARRY ARBITRAGE.

Let's look at the basics of the arbitrage transaction, as I see it.

1) GLOBEX goes bid, and stays bid relative to CASH.
2) HFT simultaneously offer on GLOBEX and bid in CASH.

This could be listed constituents, synthetic portfolios, options market, dark pools, previously acquired holdings, etc.

The HFT firms are a competitive group and so they are all trying to reduce the SPREAD at which they will initiate the arbitrage.

The point is that GLOBEX has to stay bid. This takes serious order flow. It could be speculative, it could be to fill prime brokerage orders (guaranteed VWAP . . . . cough, cough), it could be short covering, or it could be because institutional offers are being pulled (there are probably more scenarios here).

The same idea applies to the relative offer on GLOBEX to CASH.

Here's my answer. ES and SPY will diverge (very slightly) from SPX ticker. Ditto for NQ and YM, RTY, etc.

Remember, GLOBEX is bid and the arbitrageurs are lifting offers in CASH against filled offers at CME, CBOT.

There are layers of arbitrage at work here.

Another name for the the spread is the PREMIUM, or PREM. Another name for the arbitrageurs is "program trading".

 

[Real Money]

Have you given a thought who you will execute through? I assume TOS is just for research and you are going to want to automate this.

Let me just make one thing very clear.

---------- I DO NOT TRADE USING AUTOMATION ----------

So all of the comments about getting hanged using an automated system are just hot air from this idiot REDP1800.

When I said systems I meant using ThinkScript to develop custom studies and algorithms for analytics***.

Daytrading the aforementioned spreads does not require 'execution advantage' of any special kind.

***ThinkScript is one of the few affordable resources for developing custom studies. You can create studies, name them as objects in the script and then manipulate them using algorithms and other mathematics and statistics functions.

Also, when I said

"NQ/YM is a scalpers dream come true"

I meant scalper to mean an OUTRIGHT SCALPER / DAYTRADER!
(i.e. someone who takes outright risk).

I never told anybody to go scalp NQ/YM! << This is NOT possible for retail and DOES require an 'execution advantage'.

NQ/YM is a CROSS HEDGE.

Cross hedging on a small time-frame can be useful for trade management.

 

[bone]

Well, theoretically, the constituents are supposed to dictate where the index is, so futures need to be bought or sold to reflect the change. But in reality I think Futures lead and stocks catch up.
But I can't say I have found anything tradable there yet.

Unless you are situated at a major prop firm with a very high dollar ECN you are wasting your time if your intent is legitimate arbitrage. It's a pure speed game dominated by names like DRW, Jump, Geneva, Belvidere, Peak 6, etc. etc. By arbitrage I would mean something along the lines of a basket of stocks versus an index future; that type of thing.

As I mentioned earlier in the thread, there are plenty of opportunities for swing trading inter market index spreads.

 

[qlai]

you are wasting your time if your intent is legitimate arbitrage

I'm not looking to arbitrage it, but I would like to understand this in terms of orderflow.