My understanding is that program trading is buy/selling the index futures and selling/buying the underlying stocks. It would seem to me that it would cause the stocks and futures to move in opposite directions, but my observation is that when the stocks are going up, for whatever reason, the futures are going up. There can be some really fast moves in the e-minis and I am wondering if this sometimes can be because of program trades. I have only recently began monitoring the prem, mostly by just watching cash and futures nas 100 and sp 500 and subtracting. Any thoughts on the subject would be appreciated.
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prem, futures, program trading
- Thread starter nljones5
- Start date
its the spread between the two that causes the divergance.
I know it is the divergence that causes the program trading. Let me see if I can make my question a little clearer with a hypothetical situation. Let's say hl camp fair value is 2. The spread is three. Program trading kicks in. Lots of green arrows on stocks, stocks are being bought. But if the futures are being sold to close the divergence gap, they would be going down, right? My observation (really just yesterday) is that the futures go up when the stocks go up and down when the stocks go down.
This question centers around using prem for quick trading ideas and program trading may happen too fast to be of much use in trying to scalp or trade e-mini.
This question centers around using prem for quick trading ideas and program trading may happen too fast to be of much use in trying to scalp or trade e-mini.
You are of course correct that program trading is the simultaneous buying/selling of futures vs. the underlying basket. It is a spread trade. The programs are initiated when the relationship between futures and the underlying exceeds "fair value". We know that futures are "cheaper" to be long then the index. Why? Because the margin on a futures contract is approximately 3-4%, while the overnight margin in equities is 50%. Thus the excess capital that one retains by being long a simulated portfolio using futures instead of stocks can be lent out in the credit markets, either overnight, tied to the 3 MO. T-Bill rate or the broker loan rate. The flip side is that equities pay dividends(or at least used to) while futures don't. The equation for fair value is simply the interest earned differential between futures and stocks minus the dividend yield of the underlying.
To keep things simple we will use a rising market as an example. Let's say that fair value between ES an SPX is 5pts. That would mean that at 5 over futures and cash would be at an equivalent "cost of carry". The interest savings minus dividend are figured in to this magical 5pts. Now for whatever reason i.e. short covering, a large institutional order, ect., futures begin to spike higher. All of a sudden they are 7pts. over cash. A program trader will quickly lift the offer in the SPX components (most the time computer generated trades) and sell futures into the rally. This should cause the "spread" between ES and SPX to come back to around 5pts. again. It does not necessarily mean that either CASH OR FUTURES WILL STOP RALLYING. It merely means that for the time being cash will probably "catch up" with futures. This naturally works the same way in reverse when the market spikes lower. Only rarely do the indexes themselves trade out of whack to futures.
To keep things simple we will use a rising market as an example. Let's say that fair value between ES an SPX is 5pts. That would mean that at 5 over futures and cash would be at an equivalent "cost of carry". The interest savings minus dividend are figured in to this magical 5pts. Now for whatever reason i.e. short covering, a large institutional order, ect., futures begin to spike higher. All of a sudden they are 7pts. over cash. A program trader will quickly lift the offer in the SPX components (most the time computer generated trades) and sell futures into the rally. This should cause the "spread" between ES and SPX to come back to around 5pts. again. It does not necessarily mean that either CASH OR FUTURES WILL STOP RALLYING. It merely means that for the time being cash will probably "catch up" with futures. This naturally works the same way in reverse when the market spikes lower. Only rarely do the indexes themselves trade out of whack to futures.
Here is 1 thing I always wondered about program trading. When the curbs go in, the program traders are suppose to stop trading, at least those with morethan 5 mil, but how does anyone know if these guys actually stop trading, do they have to sign agreements, is there any oversight. I have seen curbs go in and not much seems to happen, anyone out there know? Thanks
Originally posted by Pabst
You are of course correct that program trading is the simultaneous buying/selling of futures vs. the underlying basket. It is a spread trade. The programs are initiated when the relationship between futures and the underlying exceeds "fair value". We know that futures are "cheaper" to be long then the index. Why? Because the margin on a futures contract is approximately 3-4%, while the overnight margin in equities is 50%. Thus the excess capital that one retains by being long a simulated portfolio using futures instead of stocks can be lent out in the credit markets, either overnight, tied to the 3 MO. T-Bill rate or the broker loan rate. The flip side is that equities pay dividends(or at least used to) while futures don't. The equation for fair value is simply the interest earned differential between futures and stocks minus the dividend yield of the underlying.
To keep things simple we will use a rising market as an example. Let's say that fair value between ES an SPX is 5pts. That would mean that at 5 over futures and cash would be at an equivalent "cost of carry". The interest savings minus dividend are figured in to this magical 5pts. Now for whatever reason i.e. short covering, a large institutional order, ect., futures begin to spike higher. All of a sudden they are 7pts. over cash. A program trader will quickly lift the offer in the SPX components (most the time computer generated trades) and sell futures into the rally. This should cause the "spread" between ES and SPX to come back to around 5pts. again. It does not necessarily mean that either CASH OR FUTURES WILL STOP RALLYING. It merely means that for the time being cash will probably "catch up" with futures. This naturally works the same way in reverse when the market spikes lower. Only rarely do the indexes themselves trade out of whack to futures.
PABST,
What indicator do you use to track the cash?
The conventional indicator to measure program trading has been TIKI...In the past 3-6 months, this indicator has had a markedly different pattern to it than I have seen in the past...Recently, instead of hitting the upper or lower band once, it will hit it 5,6,7 times in a row and often will touch the upper and lower boundary in the same 5 minute bar...
In the past, a simple yet pretty effective way of using TIKI was to wait for a TIKI high or TIKI low (+/-22) and then "fade" that move...In other words, if TIKI hit 22, you would be a futures seller and if TIKI hit -22, you would look to be a buyer...Since all things must come to an end, nowadays instead of the single TIKI extreme, you will now get the 3,4,5,6 in a row that just hammer the market higher or lower, which is also consistent with the price action these days...Instead of getting measured movement and trends with building momentum, we now get the spikes up followed by spikes down which are compounded by the program traders "piling on" all at the same time...
I guess my point to this post is that TIKI, as it once worked, has seemingly lost that magic...I think it is still effective to look at TIKI extremes combined with high(low) TICK readings...But even so, it all comes down to price anyway and the TICK and TIKI can only do so much...
In the past, a simple yet pretty effective way of using TIKI was to wait for a TIKI high or TIKI low (+/-22) and then "fade" that move...In other words, if TIKI hit 22, you would be a futures seller and if TIKI hit -22, you would look to be a buyer...Since all things must come to an end, nowadays instead of the single TIKI extreme, you will now get the 3,4,5,6 in a row that just hammer the market higher or lower, which is also consistent with the price action these days...Instead of getting measured movement and trends with building momentum, we now get the spikes up followed by spikes down which are compounded by the program traders "piling on" all at the same time...
I guess my point to this post is that TIKI, as it once worked, has seemingly lost that magic...I think it is still effective to look at TIKI extremes combined with high(low) TICK readings...But even so, it all comes down to price anyway and the TICK and TIKI can only do so much...
Originally posted by LouiseJefferson
PABST,
What indicator do you use to track the cash?
http://www.programtrading.com/buysell.htm
You can check fair value at this site. Make sure you have cash and futures on your trading screen. Since I trade more NQ then ES I track QQQ pretty closely. Rarely out of whack much, but I'll take any info I can get. Hopefully Vulture (who is a tremendously helpful contributor to this board) can detail some of the more esoteric indicators that are used.