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Newbie Question - ES E-Mini Contracts
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Newbie Question - ES E-Mini Contracts

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Newbie Question - ES E-Mini Contracts

So as trading the ES after the US stock market closes, how does the value of the ES reconcile with the actual value of the underlying S&P500 company's stock? How does this stay in synch? Is there a daily reset?

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dannyinhouston View Post
So as trading the ES after the US stock market closes, how does the value of the ES reconcile with the actual value of the underlying S&P500 company's stock? How does this stay in synch? Is there a daily reset?

There is no necessary or mathematical connection between the ES and the S&P index -- one is not derived directly from the other.

The relative valuation is kept reasonably in step by the market. The main point of the futures markets is to hedge other asset positions. So large holders of stocks may want to have offsetting positions in ES to protect them against market moves. Others will be watching for any significant differences between them, and will buy one (or a basket of stocks similar to the S&P) and sell the other, bringing them back in line through arbitrage.

There will normally be a difference between the cash and futures markets due to a variety of factors. You can look up "fair value" on the CME web site here for details: Calculating Fair Value - CME Group .

The relevant part is this:


Quoting 
Fair value is the theoretical assumption of where a futures contract should be priced given such things as the current index level, index dividends, days to expiration and interest rates. The actual futures price will not necessarily trade at the theoretical price, as short-term supply and demand will cause price to fluctuate around fair value. Price discrepancies above or below fair value should cause arbitrageurs to return the market closer to its fair value.

The following formula is used to calculate fair value for stock index futures:
= Cash [1+r (x/360)] - Dividends

During non-stock-trading hours, the price of ES is purely due to buying and selling in ES itself -- which, of course, is the case any other time, too. . The return to "fair value," as well as the departures from it, is ongoing and approximate, and is always due to buying and selling forces alone.

Bob.


Last edited by bobwest; July 13th, 2016 at 10:20 AM.
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Thanks. This is hard for me to get my head around it. Unlike crude oil, where you are buying and selling actual barrels of crude, the ES is purely a fictitious instrument.

Appreciate the reply.

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dannyinhouston View Post
Thanks. This is hard for me to get my head around it. Unlike crude oil, where you are buying and selling actual barrels of crude, the ES is purely a fictitious instrument.

Appreciate the reply.

Actually, it's not all that different.

First, you're not really buying or selling any barrels of oil. You are entering into contracts to buy or sell oil at a later date. Since futures are a hedging vehicle for large commercials (as well as a speculative vehicle for us ), there must be a connection between the current physical ("spot") price and the futures price, but there also will inevitably be a difference that involves, among other factors, the cost of money and of holding inventory (and who knows what other considerations, such as anticipated supply/demand of physical oil in the future.)

I don't pay any attention to these things, although I'm certain that people who are actually going to take or receive delivery do, but you have to expect that there will be differences between the current spot price and the futures price, and that this difference will tend to narrow down to zero at delivery date. In the meantime, there will be a "theoretical value", just as there is with the ES futures, and arbitrage will tend to keep valuations close to that value, but not necessarily at it all the time.

If you want to, you can take a look at this article in Wikipedia (since I only skimmed it, not really being too much into the whole question, I can't summarize it. ) https://en.wikipedia.org/wiki/Futures_contract -- But it makes the point of the different factors going into the current futures price, which is not the physical price you would get right now if you went out and bought some real oil on the spot market.

A simpler way to get the point:

Here's a chart of the actual daily spot price for West Texas Intermediate (WTI), which what is traded with CL:

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(Source: https://ycharts.com/indicators/crude_oil_spot_price )

So if that's the price of physical oil right now (or actually, the beginning of this week), here's the CME CL price for different contract maturities. Just look at the "Prior Settle" price. It is not actually ever the spot price, and -- at least for now -- for contracts that are further out, the prior settle price is higher. I'm not expert enough to know the factors this reflects, but the point is that they are all current estimates of a future value, as set by supply and demand in the futures market, not just the physical one:

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The futures price of oil is also somewhat a construct based on the likely factors that determine the present value of something to be actually bought and sold in the future, and is kept in reasonable line by buyers and sellers in the futures market as time goes on. It will not be a "real" price of barrels of oil until the oil is actually delivered.

Bob.

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bobwest View Post
you have to expect that there will be differences between the current spot price and the futures price, and that this difference will tend to narrow down to zero at delivery date.


The futures price of oil is also somewhat a construct based on the likely factors that determine the present value of something to be actually bought and sold in the future, and is kept in reasonable line by buyers and sellers in the futures market as time goes on. It will not be a "real" price of barrels of oil until the oil is actually delivered.

Hey Bob - Nice and informative post. One thing I disagree on is the quoted bits above though.

I don't believe that the delta between spot and future tends to narrow to zero at delivery, and that the price won't be real until you take delivery.

My understanding of the nature of futures contracts (other than for speculations) is that hedging means that whomever is doing the hedging is protecting themselves against future fluctuations in price.

So air carriers who believe Oil price is going up in the future may purchase CL futures today with today's price, but take delivery into the future.

Is your understanding different?


Last edited by xplorer; July 14th, 2016 at 01:51 PM.
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Hey Bob - Nice and informative post. One thing I disagree on is the quoted bits above though.

I don't believe that the delta between spot and future tends to narrow to zero at delivery, and that the price won't be real until you take delivery.

My understanding of the nature of future contracts (other than for speculations) is that hedging means that whomever is doing the hedging is protecting themselves against fluctuations in price.

So air carriers who believe Oil price is going up in the future may purchase CL futures today with today's price, but take delivery into the future.

Is your understanding different?

As to hedging, not different. As to when a "purchase" takes place, yes, very much so, if I understood you correctly.

The "purchaser" doesn't get, or pay for, any oil until delivery; the "seller" doesn't get paid for any until then, either.

Example: buy oil (CL contracts, actually) today at, say, $45.38. Suppose the price goes up to $50.00. Your long position is credited, and you actually receive in your account, the difference of $4.62 when the accounts are all marked to market at the end of the day. But you are going to need that 4.62 when you actually take delivery of the oil. Assuming no other price changes, you will pay the actual going price at that time, which will be the then-going price of $50.00. You will fork over the original purchase price of 45.38, and will have the remaining 4.62 in your account already, so your price is effectively what you originally wanted: $45.38. But the buy actually goes off at the purchase price at delivery date (which is the spot price at that time -- the price you can buy oil at if you go out and just buy some for cash then.)

The inverse applies to the seller: His futures short position loses $4.62, since the price went up, but the actual sale will be for $50.00. So he gets 50.00, less the 4.62 he has already paid out as his futures account has been marked to market, and puts $45.38 into his pocket.

Both parties were hedged, because they both effectively transacted business, on a net basis, at the original $45.38 -- after adjustments to their margin accounts are taken into account.

And there was no actual purchase of any oil until then, either.

That lets unhedged traders, like us, just pocket or lose the difference in price as our P&L -- by closing out ahead of delivery -- and not have to ever come up with the very major bucks it would take to actually pay for the amount of oil specified in the contract, which probably none of us could afford, or would want to.

Bob.

Edit: I just noticed that in my zeal to have an example, I didn't quite use the right numbers. Of course, you would get credited or debited the cash value of the 4.62 price change, which, at $10.00 per .01, would be $462.00. But the basic idea is right, anyway....


Last edited by bobwest; July 14th, 2016 at 04:53 PM.
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bobwest View Post
As to hedging, not different. As to when a "purchase" takes place, yes, very much so, if I understood you correctly.

The "purchaser" doesn't get, or pay for, any oil until delivery; the "seller" doesn't get paid for any until then, either.

Example: buy oil (CL contracts, actually) today at, say, $45.38. Suppose the price goes up to $50.00. Your long position is credited, and you actually receive in your account, the difference of $4.62 when the accounts are all marked to market at the end of the day. But you are going to need that 4.62 when you actually take delivery of the oil. Assuming no other price changes, you will pay the actual going price at that time, which will be the then-going price of $50.00. You will fork over the original purchase price of 45.38, and will have the remaining 4.62 in your account already, so your price is effectively what you originally wanted: $45.38. But the buy actually goes off at the purchase price at delivery date (which is the spot price at that time -- the price you can buy oil at if you go out and just buy some for cash then.)

The inverse applies to the seller: His futures short position loses $4.62, since the price went up, but the actual sale will be for $50.00. So he gets 50.00, less the 4.62 he has already paid out as his futures account has been marked to market, and puts $45.38 into his pocket.

Both parties were hedged, because they both effectively transacted business, on a net basis, at the original $45.38 -- after adjustments to their margin accounts are taken into account.

And there was no actual purchase of any oil until then, either.

That lets unhedged traders, like us, just pocket or lose the difference in price as our P&L -- by closing out ahead of delivery -- and not have to ever come up with the very major bucks it would take to actually pay for the amount of oil specified in the contract, which probably none of us could afford, or would want to.

Bob.

Wow. Lots of details here. Thanks for that...


It sounds like we agree on the bottom line, i.e. who's doing the hedging and "pays" (buys) in advance for the futures contract will have a net benefit if the spot price goes up.

We still assume they hedged because they do need the 'goods' (whether it's oil, grains, etc.) delivered to them but they anticipated price fluctuations and they were right.


I did not know the details about transaction mechanics, i.e. when the "purchase" takes place, or account balances, but that does not change the bottom line, does it.


I also agree on the unhedged traders like us - I had simply removed ourselves from the equation as speculators, I was solely focussing on the hedging part.

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xplorer View Post
I did not know the details about transaction mechanics, i.e. when the "purchase" takes place, or account balances, but that does not change the bottom line, does it.

Right. That's all mechanics, basically.

Bob.

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dannyinhouston View Post
So as trading the ES after the US stock market closes, how does the value of the ES reconcile with the actual value of the underlying S&P500 company's stock? How does this stay in synch? Is there a daily reset?

The stock market never "closes" per se. You will have earning that come out after hours and see the stock move high or low, and that could also affect the cash index value, and hence the futures markets. Consider that certain transactions also occur outside the exchnage (black pools) and that affects cash and futures markets as well. Consider that not only earnings come out of the market but all sorts of news that can affect the cash index and stocks, and again the futures as a result.

Multinational organizations could be trading on two exchnages like LSE and NYSE, and so if one is part of an index, it will affect it in cash value, and then on the futures market (ES).

If you see a gap open that is significant between the close of the day session, and the open of the night session is because of a chain of events, news, etc that the futures index must reflect. They all have to move in tendum not to create arbitrage.

I hope this helps.

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