Don, My point is that the arbitrageurs will keep the relationship between the two so tight that there won't be any discrepancies that could provide any clues as to market direction. Also, when the arbitrageurs trade, they wouldn't normally trade all 500 stocks. They would trade what's called a 'basket' of stocks which would represent most but not all of the index. What you risk on not having a completely perfect hedge is overshadowed by lowered transaction costs. For example: When I 1st started the dollar index arbitrage there were 20 currencies involved. I didn't trade any of the minor currencies unless I absolutely had to to balance out the hedge. Normally I'd trade d-marks, swiss, yen and the occasional british pound. Trading those four gave me a good approximation of the index movement, and I didn't have to bother trying to find markets on drachmas or punts.
Trader, Because it can be mind numbingly boring. You're either busy, or fighting to keep from nodding off. Most people don't realize that working in just one market has the drawback of having absolutely nothing to do when the market is quiet. It's the reason why so many trading floor people are excellent with crossword puzzles. I can do the one in the Chicago Tribune in about eight minutes, and my father is even faster than me. I do like the patternless ones though, they're actually a challenge.
the term fair value gets used in different guises - cnbc use it to just give a guide to people that the futures are up or down in the premarket relative to the prior cash close ultimatly it has no real meaning as it could swing either way - its just futures traders - trying to get ahead of the curve - and they can get it wrong, as well as right - but normally the futures will have settled about 30mins before the open fair value is really just based on a formula that balances the cost of a futures position to owning all the stocks there is also a fair value figure that futures pit traders estimate from the open and then trade off for the day but fair value is key to trading futures - or at least the futures' discount or premium to fair value - relative to the markets trend arbitrage is an important input to the relationship between cash and futures - but they are in no way locked together like most people think - exactly in the same way that the big is not locked to the emini - but i am taking about seconds and not minutes here! - but those seconds are where the bucks are - even for intraday trading - not just arbitrage
Well there seems to be plenty of warnings from you guys concerning Fair Value and its complexities...its not that important to me right now for my particular style of trading....think I will fool around with it though for quite some time on the side lines to see what kind of conclusions I will draw myself...thanks and hats off to all of you who posted a reply.