Someone told me that index futures can drive and lead the price movement of the underlying stock indices. Given my limited experience with futures, I am puzzled. My textbook knowledge tells me that index futures are derivatives of stock indices. Therefore, futures prices are derived from stock indices. It should be indices that drive and lead futures. Logically, there should not be price feedback from futures back to stocks. Can the more savvy members here tell me what did I miss?
stock index (eg S&P) is based on a formula with various stock prices and its weightage in it. so if stock price goes up, stock index goes up. The number is calculated every x minutes. I don't think people bother to calculate it every single second. Index futures (eg ES ) is tradable. big boys, retailers, bankers, you, me, Americans, Europeans, Asians trade index futures. If more people buy it , index futures will go up. the number changes on real time basis. So stock index and index futures may not have 100% correlation.
They both can drive each other. If they get too far apart theirs now a place for arbitrage. Plenty of firms that can take advantage of these differences. Same can go for an ETF and it's underlyings. Another example would be Canadian/U.S interlisted stocks, if spread gets far apart theirs an opportunity for someone to arb that out too. Retail just doesn't have the size and trade cost to compete in these opportunities.
It's neither. The actual story... Investors express their optimism/pessimism partly in reaction to news of all types. Years ago they responded to news by buying/selling "baskets" of stocks. While some may still use baskets, now they can accomplish the same financial objective with buying/selling index futures or ETFs. The futures appear to "lead" the index because futures price changes are reflected almost instantaneously while it takes a little time for stock price changes to work through the system to be reflected on the tape. Years ago I tried arbing the spread sometimes when it looked especially wide/narrow, but no joy. I don't know if someone with HFT capability could succeed at it.
Exactly. There are hedging techniques that sell the futs and buy the stocks to close the spread between them, and certain errors can lead to an imbalance, sometimes the futures would be no longer the derivative, but the stocks would become the *derivative*
Program trading desks executing large portfolio orders benchmarked on implementation shortfall will routinely hit futures first to minimize slippage.
%% Exactly, Metamega. Same reason a derivative- a mortgage/mortgage rates, can drive real estate markets;+ cash counts also, in real estate or stocks. Any real estate buyer /seller could show you better deals on cash real estate or better deals on credit real estate; but 100% of foreclosures are caused by credit[leverage] in real estate. Plenty of logic, plenty of logic, in stocks,SIF, derivatives, real estate; but not limited to logic @ all. LOL Good question, Learner 88
Futures lead stock indexes only outside of the regular market session simply because they are traded 23 hours a day.
Thank you for all the replies. Based on them, I reached the conclusion that the price feedback goes in both directions due to arbitrage mechanism. A more interesting and more difficult question now would be ... who has the greater influence? Does futures have greater price influence over indices or the other way round? Based on historical precendents, it seems futures have the greater influence. During the 2010 flash crash, reports blame it on Navinder Sarao who manipulated the futures markets, not index markets. In the 1987 biggest intra-day crash in stock market history, the manipulation again started in the futures market, not the index market. However, I have no logical explanation why futures seem to have a greater influence. Any help from the more experienced members here?