relationships between index, etf, futures

D

doji

ok here is my question:

What is the relationship between instruments with the same underlying? For instance DIA, YM, $INDU, or SPY, ES, $SPX.
The futures versus the cash is pretty clear, so I guess what I am interested in is the relationship between the etfs and the cash and the etfs and the futures. A pointer to a white paper would be much appreciated.

I think my confusion lies in the realm of supply and demand, if someone puts on offer up for 1 million DIA and that should drive the price of DIA up while at the same time they are selling 2000
YM contracts the futures are going to drop... now obviously this is were the arb houses are going to be pretty happy, so that may be my answer but I would appreciate a detailed technical account if anyone knows of one.

Thanks,
Doji
 
I am not trying to be a smartass, but I suggest you think about it first, come up with a theory, post it, and then see the responses.

I will give you a clue - people that are trading these related instruments "move" liquidity from one instrument to the other. The other thing that you have to consider is the tax laws for each instrument, and how cheap it is to trade them.

nitro
 
Quote from doji:
I think my confusion lies in the realm of supply and demand, if someone puts on offer up for 1 million DIA and that should drive the price of DIA up while at the same time they are selling 2000
YM contracts the futures are going to drop... now obviously this is were the arb houses are going to be pretty happy,
More...
What you describe is an arb trade by itself and the only reason someone might do it is if they could capture a definable premium on a pricing imbalance (although the typical arb trade would be to buy the DJIA underlyings basket and sell the futures if the futures were sufficiently overpriced relative to the cash index).

Mostly the relationship between the three components is that at any given time, one of them (not always the same one) will tend to lead overall price action and movements in one will tend to impact the other two through arbitrage. So it's helpful to understand where support and resistance is for each so you can more quickly get a handle on why the overall price action is doing what it's doing - e.g., if the YM seems to be stalling in the middle of nowhere (relative to its expected support or resistance) but the DIA is also stalling at a key SR - you have a reasonable clue that it's the DIA trading that's currently leading the YM (i.e., simplistically - the trading action in the DIA that's causing it to stall at a DIA SR level is ultimately being immediately translated into trading in the underlying equities because the DIA trust (among others) has to arb the DIA against the underlying equity basket - then the action in the equities is affecting the futures contracts through similar arb trading).
 
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