I think the correct & accurate answer will only come from someone has already taken this seminar: http://www.programtrading.com/seminars.htm In order to use the fair value here properly: http://www.programtrading.com/buysell.htm Any graduate here?
The PREM feature is only telling you at that instant in time what the difference between the cash and the futures contract is, and this should not be confused with FAIR VALUE, which is a number that is similar, although slightly different depending on the source calculating the assumed FAIR VALUE between the futures and cash index at any point in the lifespan of the futures contract. Therefore, the PREM can trade at a "premium" to FV or a "discount" to FV... Nowadays, with such a low interest rate factor calculated into the FV equation, the PREM to cash contract is extremely low. In fact, it trades within 1-2 points of parity with the cash contract as opposed to a substantial double digit premium to cash back in 1999-2000 when the interest rate component of the equation was much higher. Therefore, the margins are thinner in the arb, I would assume since there is less to "capture" in this imbalance. Think for a minute about an arb executed as contracts rolled over in 1998-2000 when you had a 15-25pt premium in the futures to the cash that would eventually erode to 0 over three months. Now that same spread is somewhere in the vicinity of 2-3 points for the same duration... I don't know a heck of alot about the index arbitrage or how it is executed nowadays, but I have noticed that decline in the PREM over the past 3 years and am just drawing my own conclusions and assumptions. Someone might have some better information about the implications of this decline...
its great to hear how i am wrong - but in fact everyone is just agreeing with me its just that i have never really bothered with the use of the word PREM - as a definition i tend to use the terms - "premium" or "discount" to cash to alert myself to the state of the market and of course trading opportunities and in fact, ironically, i never use Fair Value ( as agreed by me and all hear to be the calculation that is based on interest and dividends etc) i am only interested in specific trading opportunites and changes to the premium that occurs during the trading day which accuratetly signifies a change of sentiment in market direction with so many people telling me i am wrong - i am going to throw in the towel and agree with all of you - but i am going to stick with my view as it works for me, specifically as a leading indicator of market direction
Right on the nose. BTW if this is taken too mathematically and you act like a robot, you will get hurt. A trader would (should ?) use the more empirical approach and see if HIS stocks take off/break down with PREM above/below FV. Nothing is written in stone day in and day out...Some days some stocks don't respond to PREM when they "should" - Other days they are glued to the spoos. It is your job as a trader to decide this as early as possible and to continue to evaluate as the day goes by... nitro
RE> BTW if this is taken too mathematically and you act like a robot, you will get hurt. A trader would (should ?) use the more empirical approach and see if HIS stocks take off/break down with PREM above/below FV. This is exactly what I've been doing daily on 3-4 stocks I'm trying to learn to "read the tape" on as they relate to FV. Excellant point.... Good trading all, mrktwiz
There is an article in the Wednesday July 24 WSJ Section C1 on Program Trading...Pretty elementary but still an interesting read. I strongly agree with the article that if it weren't for trading curbs, I think we would have seen another 10-20% drop in one day these last few months (even outside the first day post Sept 11 open) and probably would have seen an equally big if not bigger rise than the 489 point gain (really about 700 points from the low of that day.) nitro