To begin with when we rollover to the next quarters future contract (lets use ES mini for example) the premium of the ES mini is usually about 10 points above cash. My question then is, what if in a totally hypothetical scenario you purchased the ES mini at 10 points premium to cash (aka the first day of the new rollover contract) and held it to the last day of that quarter, and the cash index showed no change in price over the entire quarter would you then still lose money due to a time value decay on the premium as the future index fell to parity with the cash index? I am very curious if someone could help me out here. The reason I have never really concernced myself with this is that I usually daytrade them so I never worried about a decay in price. (If one even exists, aka my question.) Thanks in advance.
Yes, the value of the future depends on time to expiration, interest rates, dividends, etc. As time goes by, the basis (difference between futures and cash) gets smaller and smaller until expiration. Most firms calculate the time to expiration on a daily basis to figure out the fair value of the future versus cash.
If it is the case that the time value decays on the futures vs cash. Then wouldnt it be a profitable trade to do the following: Go Long 800 SPY and Short 1 ES mini at the start of the new contract month and close out as the spread narrows towards the end of the contract period?
In theory, that would make sense to capture the basis (about 2 ES ticks, basically). However, since both products are not fungible (as far as I know), you will have to put up enough margin on both products for the duration of the position to cover market movement and volatility. I am sure you can find better use for the money than this. I am not fully informed in this area and have not researched it, but it wouldn't seem like a worthwhile trade.
The weighting would be 500 SPY vs.1 ES. It's 800 QQQQ to equal 1 NQ. And no, that SPY-ES trade would be a scratch. The overnight margin on the 500 SPY (500x$120.00x.5%) could be invested at a risk free quarterly rate of about 4%. Of course the long SPY position would allow you to capture some dividend income but "net-net" the position would cost you about .2% per month to carry. That would be the exact amount you would collect in futures premium on the convergence part of your trade. Hence the trade is arbed out.
Thanks pabst for that answer..yes I meant to say 500 spy vs the es mini...my brain was thinking the nq as I typed it. Excellent answer I appreciate it.
please tell me how to get such a high risk free return ! -The overnight margin on the 500 SPY (500x$120.00x.5%) could be invested at a risk free quarterly rate of about 4%-
Hopefully Seth you know the difference between rate and return. A 4.25% three month LIBOR means a rate to term of that amount .
oops ... must have been the belgian brewsky I was having with dinner ... thanks for the correction ... sorry for the confusion on my part