I guess I'm not getting it. How is the fair value for a futures contract related to the trading any particular stock?
Well, it's the theory that all boats float in the same water, so when a wave comes along, it tends to lift all boats... or when the S&P futures are up, most stocks tend to go up. Now this is not always the case, as there are certain sectors that don't generally go with the S&P futures (ie airlines). But it's still a good rule of thumb. An excellent example of this is GE. GE has a weighting that is about 7% of the S&P 500 (last time I checked). So if the S&P futures go up it's almost positive that GE will go up. There are a few things driving this phenomena. One is the arbitrage people. Large players will play off the difference between the S&P futures and the stocks that are in the S&P. When there is a difference in price that is less than the fair value, they will buy "buy the spread" because there is almost 100% certainty that the difference will return to fair value at which time, they can "sell the spread" and lock in the profit. THey do the same thing on the short side. The use the S&P futures as the leader and buy/sell the stocks accordingly. So, if you have a stock that is in the S&P 500 and there isn't anything "unusual" going on with that stock (rumors, earnings, industry news), it should float with the futures. If the futures go up, it should follow up the same percentage and vice-versa on the short side. So, if you see the spread increase significantly past fair value (which is the amount where the spread is at equilibrium), it's highly likely that your stock will go up. This is because the arb guys need to buy all the stocks so that they don't lose their shirt on the arb. This also works with other futures/indices. For example, oil futures and the oil index, oil stocks... gold futures and the gold index, stocks... OEX, Russell 2000, etc. So why do other stocks go up if they aren't in the S&P 500? Well, they are probably in a group and the stock (or stocks) with the largest market or capitalization in that group are probably in the S&P 500. So, when a group's leader goes up, other stocks in the group tend to go up. So, S&P futures go up, they lift the stocks in the S&P, the stocks in the S&P lift their respective groups, and your stock goes up. If it doesn't that's giving you some very important information.
We spend quite a bit of time making sure that our traders have a comprehensive understanding of the relationships between individual stocks and sectors vs. the overall market. This understanding is primary to trading and must be learned well. You are sharp to want to get more info on the relationships, and Cash's explanation gives you some of the basics.
Is there a material advantage in paying $60 /month to get the full contract SP futures quote (i.e. SP Z1 or SPH2 in most quote services) as opposed to just subscribing to the E mini futures (i.e. ES Z1 or ES H2) which is currently given away free by the CME for 6 months. Wouldn't the very tight and efficient arbitrage between the 2 contracts negate the need to pay for the full contract? Thanks
Either one is fine for the average trader. We find that we need the additional edge of a live feed (audio) from the CME trading floor. This really helps by telling us things that we wouldn't see on the chart or the price ticker.
OK Don I think we got it , your traders get the best training and tools (even a squawkbox from the pit) so we should all apply at your firm. Now I have a question for somebody whose time spent on this board is not part of their job promoting business: I am trying to get a thorough understanding of this whole FV thing. As the futures kept selling off hard Monday past the close of equity trading I was particularly attentive to what would happen today at the open regarding FV and the futures. When I tuned in on CNBC at 9:00 ET, I saw S&P fut up 0.60 and heard Mark Haines say that the futures "were about right at fair value". ES had closed the Globex session at 1141.75 (16:15 on Monday) 1148 was the ES number at the 16:00 cash close, so the fut dropped another 6.25 points after the cash closed. The futures were around 1149.5 at 9:00 am today so up almost 8 points from the globex session close and up about 1.5 from Monday 4 o'clock close. Some data providers show the fut jumped back to 1149 in one minute! at 16:14 or it could be a bad tick but this is showed on daily charts of Futuresource and Quote.com but not on the 1 min chart of Quote.com. Can anybody confirm this ? This would explain CNBC numbers. My understanding is that it's the 4:15 pm close that is taken into account for the change of the futures in the morning, right?. Also why do the emini keep trading between 9:15 and 9:30 am while the full contract stops? Thank you for your help.
http://programtrading.com/buysell.htm http://www.patterntrading.com/fairvalue.htm These 2 sites have fair value. There are some good explanations of the site. the program trading site includes clearing costs, any normal slippage on executions of stocks, and the effect of NYSE trading curbs placed on the computer entry of stock orders; and therefore, are always higher for program buying and lower for program selling, than theoretical prices like those announced on CNBC. Don't use anything off CNBC for FV.
A simple way of explaining F value and think about the stocks in the S&P 500 are all worth a % of the index. When a stock is lower than it's value of the index /program trading/arbitrage buys the stock and sells the index to make up the difference and bring the stock back to it's true value. When a stock is well above it's % in relation to the index than program trading/arbitrage will bring it back in line by selling the stock and buying the index. Robert Tharp
For most trading yes it wouldn't make a difference. I wouldn't bother for most strategies. If you are doing any sort of Fair Value Opening Orders than .10 can be a lot on 2000 shares. --$200 You need to program in the exact prices of where program trading should be buying and where they should be selling that you want to join guys doing arbitrage. I'd hate to be off .10 when putting in my prices because I was too cheap to spend an extra $60 on a quote feed and Opening orders can be worth over $5000 a month to a trader.
Your post about the % of the stocks vs. the S&P index is a good one. Do you find it as hard as I do to convey the overall concept? I find that we can sometimes get new people to understand the concept for placing opening only orders, but then it fades when we try to relate it to Premium/Discount during the trading day. I think Program Trading has a pretty good definition, but perhaps too numbers oriented... Anyway, good job!