how exactly do the index arb'ers do their thing???

You have two choices(actually more,but for simplicity 2)

You can simply reverse the position before contract expiry(or on expiry/settlement price day)


You can do an EFP..Exchange for physical...There is actually a market where you can trade both sides at a predetermined price..

That is as close to what you have asked....

This is not like an option you can exercise

 

That's because no one is answering your question. I will answer after market closes.

nitro

 

Mr Nitro,

I have traded index arb at a AAA institution and am looking foward to seeing your answer...

I must not be understanding the question

 

No one trades all 500 stocks to do the arb. It’s too expensive and the slippage is ridiculous. What they do is create their own basket of stocks to replicate the index to a correlation they’re comfortable with. You cant send basket order with 500 stocks either.

I have never heard of an EFP for the SnP future and I don’t see how it could work since NO one trades all 500 stocks. Your choice is limited to unwinding the positions by yourself. The arb works both ways so you always have that chance. If you put the arb on for edge then you can take it off for a scratch and keep the edge you put it on at.

Fair value is a somewhat different calculation. Fair value is based on the cost to carry both the future ( its priced into the future ) and the cash. When you see “fair value” in the mornings for the future that’s based on the cost to carry the entire cash value of the SnP500 over night vs the futures plus the differential between where the futures closed an the cash closed. Don’t forget that the futures trade till 4:15 and the cash closes at 4.

There are also a myriad of other arbs with all the products out there too.

An earlier poster mentioned dispersion and yes this type of arb is in fact a lot like doing dispersion.

To the guy who says he gets paid to learn this stuff ROTFLMAO

 

1)I have made markets in S&P EFP's and indeed traded them...I am not alone..

2) Not sure I agree with your definition of "fair value"...

3) This trade is really not like dispersion,even with an implied correlation of 1.Technically it is an arb,but very different.....

 

The problem with trading only a subset of the 500 shares in the basket is this;

If you are long the futures and short a subset of the basket.

Then in effect you are long the shares you did not include in your basket, question then is; why not just buy them.

Unless you trade all 500 shares in the correct proportions its not an arbitrage, just a relative value trade.

 

Tao,

I dont doubt you I have just not seen an EFP for indiviudal baskets before. Thanks for the info.


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No one trades the full basket of 500 stocks to do the arb. The slippage alone would make it impossible. I didnt mean to imply its a perfect arb or pure dispersion.

 

The opportunities to capture pricing inefficiencies ( above or below fair value ) are not as high as they once were, say nearly 20 years ago.


That having been said, the Equities Derivative desks for various investment banks such as Morgan Stanley, Deutsche Bank, UBS, Goldman Sachs, conduct stock-index arbitrage for their own accounts, but also for a lot of corporate treasuries of blue-chip Fortune 500 companies.

I sat on the Bear Stearns program trading desk ( my buddy was the managing director of it back in the late 80's ) and everything was done with a push of a "button" on a very powerful Sun computer.

The stock-index-arb program trader has a monitor that shows him the "bid" quote of all 500 stocks in the SPX, as well as the calculated "offer" of all of the SPX stocks.

In that way, there is a continual calculation of just where the S&P 500 "basket" is.

 

The theoretical bid and offer of the index is no big deal these days you can configure any number of systems to show you that. The spread for all 500 stocks is a JOKE. NO one trades the 500 stock basket, even with today’s tighter spreads.

In the late 1990's and early 00's I worked for a very large derivatives firm who had market makers on many global derivatives exchanges and ran a very large prop desk with multiple strategies. We did arb in all kinds of indexes and never used anywhere near even 100 stocks in the basket for the S and P. Improvements in those days got better and better each year and I can only imagine how many light-years better then the 1980’s it was. Back in the 1980’s even the guys on the floor were running sheets and doing interpolations.

At no time could you and you still cant send 500 stock baskets not to mention that the stocks are spread on the naz and the nyse.

I agree with your other piont, the markets are obviously much more efficient these days as compared to 20 years ago.

 

I do not study arbitrage, but rather than trying to get a representative basket of stocks, couldn't you just do long/short the QQQs, DIAmonds or SPYdrs,ProFunds/Rydex/whatever to represent the cash? AND couldn't you arbitrage these intruments against futures instead?

Seems a little overcomplicated...