How market makers work in Futures

Discussion in 'Trading' started by z32000, May 4, 2007.

  1. z32000


    I'm still a little confused as how price is moved in Futures....

    I know that futures are suppose to move closely to their cash.
    But what happens if say... in the S&P, there are more buyers than sellers... then the price goes up...

    but say at the same time, in futures ES, there are more sellers than buyers...

    will the price in ES go up or down?


    if everyone agrees that futures is a zero sums game...meaning there is a buyer for every seller... just say that everyone who has a future decides to sell at the same time...
    if the futures have to keep within a close range with Cash, is the market maker forced to lose his money on the future contracts he has bought himself on reserve?
  2. bvam1


    Arbitrage will keep ES futures price very efficient (i.e. Close to fair value).
  3. The arbitrage traders and programs bring the prices in line. If the S&P cash is up, but the corresponding future is down, and the difference is large enough, these programs simply short S&P cash and buy futures, thereby making a risk-free trade. This happens so quickly and efficiently that you'd probably never notice. However, in exceptional cases of extreme volatility (such as market crashes), the discrepancy may indeed become large and sustainable for some longer periods of time (a few hours or so).
  4. There are no market makers in futures.
  5. z32000


    Please explain what you mean by arbitrage..
  6. I think the term market maker gets thrown around loosely. By definition a "market maker" as the nasdaq was structured or a specialist on the nyse had a requirement to provide liquidity against customers orders. In futures, participants (locals or commercials) in the pits had no requirement to provide liquidity, they could just turn their back to the pit. Now if there are lots of sellers and no buyers it goes nowhere until it trades at a discount to cash to arb against. With electronic order matching the role of the "market maker" has become greatly diminished.

    During the 87 crash the fed gave the nyse specialists a blank check and orders to maintain liquidity and buy (before the plunge protection system). Being decrentralized many of the nasdaq market makers just took their phones off the hook. Will bots and programs have the edge to maintain the liquidity in the event of another meltdown? I guess that's what the plunge protection team is in effect for now as well.
  7. z32000


    but how can one short the S&P cash when it strickly tracks other stock...

    so you are saying, futures affect cash and cash affect futures?
    meaning, if I was very rich and bought up almost all the future contracts...
    that would affect the cash value?

    I'm assuming when you say futures (eg. ES) and cash would be (SPX).
  8. When buying the cash it would be either the spx or a basket of stocks that most closely mirrors your index, it is unpracticle to buy the entire 500 in proper weight. Programs can track and adjust the cash (stocks) to buy or sell to fully take advantage of the discrepency between fair value and actual premuim. Do some research on fair value calculations at

  9. You can also arbitrage the futures against options, ETFs, highly correlated pairs, etc.

    In other words, there's no need to buy all 500 S&P members if there's a variance between SPY and ES.

    I've always disliked the use of the word "Futures" to refer only to e-minis. Commodity futures have dramatically different internals for how arbitrage and "market making" occurs. Intra-deliver spreading, spot market hedging, storage redelivery, etc.
  10. z32000


    the reason why i ask is that...
    I trade futures just because of the amount of leverage I can get from trading them....

    Can someone wealthy enough to buy a lot of future contracts (but not wealthy enough to by stocks) cause destablization within the futures market.

    Say for example, Warren Buffet can afford to buy 2 major companies in the S&P 500 and cause the market to slightly shift...

    but on the other hand, I would assume that he might be able to buy the entire ES contract and cause even more instabilty or wider spreads (or at least have the power to turn the entire futures contract upside down).

    Or in both cases, are you saying that both will still stay within a reasonable difference in price no matter which option he goes with.
    #10     May 4, 2007