Index future contract's relationship to underlying index

Discussion in 'Index Futures' started by TD877, Sep 21, 2016.

  1. TD877

    TD877

    In my online readings about the ES contract's relationship to the S&P index, I see two themes repeated by reputable sources:
    1) the front ES contract and underlying S&P index move step and step, minus correction for carry effect and dividends.
    2) The ES contract is a speculation based on what investors feel the "future" price of the S&P will be.

    So how can both 1 & 2 be true, since they seem to contradict each other? If they're moving in step, there seems to be very little speculation going on.
     
  2. Maverick74

    Maverick74

    The stocks that make up the index are also being speculated on. They will move lock step because of arbitrage. I'm not sure I understand your argument.
     
  3. TD877

    TD877

    In other words, if the value of ES is the same as the index value (minus dividends, interest etc), then how can the future value be considered a prediction of what the index will do in the future? It seems like just a copy.
     
  4. Maverick74

    Maverick74

    I think you are over complicating this. Think of it this way: no one is speculating on the ES independent of it's underlying stocks. When one buys an ES future, they are not really betting on the ES but where the stocks of the ES are going. In your mind you are reducing this to a single product but you are really betting on all the stocks. Or put differently, no one is actually betting on the index, they are betting on a basket of stocks that derive an index value.
     
  5. JackRab

    JackRab

    2 is totally incorrect...

    A future is based on future/forward pricing. So current underlying price + interest until expiry - dividend (depending on what underlying is). That's it...

    You could argue that it will be the future price of the underlying if one would expect only risk-free return.. (hence the interest component)... but in practice that's not how it works.
     
  6. JackRab

    JackRab

    It basically is a copy, but a lot easier to trade to get a broad market exposure than getting all underlying stocks of the index.

    The 2nd argument might be mistaken with commodity futures...

    I think those futures are more based on a future price expectation of the underlying commodity. If you look at say dec2017 wheat futures, they are not really based on the current spot price of wheat... but more on the expected crops of mid-end 2017...
     
  7. Sig

    Sig

    Both of JackRab's comments are right on. One thing to add, the one time ES represents speculation on future prices is after hours when much of the underlying aren't trading. This may lead to the propagation of the myth in the OP's item 2 when you hear newscasters say something like "futures are pointing to a down opening....". As soon as trading starts they snap into lockstep again immediately.
     
    JackRab likes this.
  8. This is incorrect, IMHO...
     
  9. Sig

    Sig

    Then you should be a billionaire by now, IMHO! On a more serious note, what leads you to feel this is incorrect, it's something that can be easily demonstrated by formula compared with observation and no-one has shown it to be false yet.
     
  10. I was specifically referring to the statement "2 is totally incorrect...", rather than the cash-and-carry "no arbitrage" pricing.
     
    #10     Sep 22, 2016