some primitive questions from a newer trader, for someone that understands or knows the inner workings of these exchanges. 1) What mechanism is in place to ensure minis move the same as the small contract? Is it purely up to buyers, sellers, and arbs? Or does the exchange do something to adjust price? 2) Same thing makes me curious about movement of different calendar months being the same between minis and the main contracts -- is this purely done by arbs? (i would think the risk might be too large arbing this since liquidity is often low and prices tend to move opposing directions quickly in certain contracts (ie nat gas)) 3) kind of related (and my intuition to answer #1 and #2): on market depth i often see buy/sell bids on qm and qg that hover simultaneously lower and higher than last traded prices of large number of contracts (ie 50 buy at 5.80, 50 sell at 5.90 - all will trade price may be 5.85). Is it safe to assume this is computer program arb? These bids seem to often float and move quickly - is this arb (or bid/ask manipulation) done by the exchange itself as a service to keep minis priced the same as big contracts, then? And lastly, is it actually arb or are these superficial orders created by a nymex program that don't get filled (i never buy blocks of 50 contracts) even if the opposing side hits the price ?? I just can't imagine the exchange arbing and risking such huge loss on illiquid contracts that can turn on a dime, but at the same time there has to be a mechanism in place to keep minis priced the same as big contracts. that's my common sense.
I think you'll find spreaders play a part in what you're seeing. TT autospreader or similar will likely be the cause of the floating bids/offers as the trader tries to pick up an edge from the outrights against the exchange quoted spread markets.
It's just arbitrage. Even in a thin market, for pros, there are also other ways of laying off risk, e.g. hedging in the underlying directly, EFP, trading closely related markets, etc., so even in what looks like a thin market, there are usually opportunities for arbitrage somewhere, which quickly closes any gaps between minis and large contracts.
conceptually, its sort of amazing a (mini) financially settled contract can precisely mimic physically settled ones solely based on the whims of the trading public. As if the only thing QG has to do with NG is the fact QG has the name 'natural gas' - and that gives the trading community enough to keep them valued the same. I can understand physical delivery helping to keep prices in line - but it seems bewildering to me how this works so well without delivery (on minis).
It has to do with fungibility (directly in some cases, e.g. 33 oz vs. 100 oz gold) and predictible relationships between the products traded. While they are different contracts, with somewhat different underlyings, there is still a price relationship that is a result of actual physical or economic characteristics. It is the same reason why the price of wheat will never be less than that of corn. Wheat has more protein, so when the price of wheat drops to near corn, livestock feeders will switch. When it rises, they will switch back. With more closely related contracts, e.g. petro based, a gallon of crude has a certain ratio of products (although they vary with specific type). When refined, there is a predictable relationship between them and the base product. That's why people trade the crack spread, the crush in beans, they yield curve, etc., and in each case, the trading of one against the other eventually brings them back into historic (and "real") relationships. It's eventually and ultimatly not market perception but real fundamentals that drive spreading and arbitrage. Whether they are physically or $$$ settled is immaterial, as cash is the ultimately fungible settlement commodity, allowing the purchase of the underlying, just as physical settlement allows for the easy selling of the underlying. If it helps conceptually, it is worth knowing that physically settled commodities are very rarely delivered (unless you are Con Ed or Quaker Oats). When you get "delivered" in beans, for instance, you will actually receive a small receipt telling you that you now own 5000 bushels of beans in a grain elevator, not a carload of beans on your lawn. You can sell them with a phone call that is no more difficult than selling 100 oz of gold in a vault somewhere. So, in reality, physical delivery is not that different from cash settled.