Index Market Dynamics: E-minis, pits and cash markets ?

Discussion in 'Trading' started by chinook, Aug 23, 2003.

  1. Lets' take a look at SPX, NDX and INDU. All of these cash indexes have their futures contracts traded in the pits and e-mini versions electronically. I'm trying to figure out how and why the cash markets move when the futures market make a steep move.

    Last example was the 08-21-03 "erroneous trade by Goldman Sachs" or "Cohen's hedge fund" where ES was heavily dumped. Recently, we also saw YM taking a nose dive after a fat-finger mistake of selling 10,000 contracts. The cash markets immediately reacted to these moves although in the case YM they didn't go all the way down with it.

    So why does the cash market react to these? I have the following

    1) Funds and other big players notice the downward steep move in the futures markets and assume that horrible bad news is out and start dumping the stocks. Possibly most of these players have programs that kick in when the spread between the futures and stocks is over a set limit and then start dumping too.

    2) Arb players (their software) detect the discrepancy between the futures and cash market and they sell the stocks and buy the futures pulling the cash market down.

    These are my simple ideas. Does anyone have other suggestion show a move in the futures market effect the cash market.


  2. I would say that the answer lies in your statement #2.

    Program Trading desks from Morgan Stanley, Goldman Sachs, Deutsche Bank, Lehman Bros, etc. would detect the discount in the futures contract and jump in and "buy futures while selling baskets of S&P 500 stocks" in order to arb-out the pricing "inefficiency". This is nothing new. In fact, they have been doing it for the past 15 years.

    In the end, this arbitrage opportunity winds-up pulling the cash and futures markets back in-line.