What is the influence of the ES to the actual index in terms of order flow influence?
What is the relationship between E-mini S&P futures and the actual S&P index? Besides the obvious, one is cash the other is a futures product. What I'm basically asking is how does buying/selling in one product actually influence the other? If for example someone sells 1000 contracts of E-mini futures.. how does that affect the S&P500 Index short term direction? The trade they've made should only affect the futures market. The seller isnít technically selling shares in each individual stock within the SP500, so how does the cash market order flow adjust to this hyperthetical sell order within the futures market?
The E-mini S&P futures is the leading instrument. When news hits the market, it is easier to buy or sell ES futures compared to buying and selling the individual stocks. This temporarily increases the differential between futures price quote and the fair value calculated from the index price. When the differential is large enough, arbitrageurs will try to simulataneously buy the futures / sell the stocks or alternatively sell the futures contract and buy the stocks until the differential disappears again. The simultaneous buying or selling of different stocks leads to a higher correlation between individual stocks which will lead to an overbought or oversold reading of the NYSE and NASDAQ tick indicator. You can exploit the tick readings to enter an exit positions, if you keep track of the current trend.
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Thank you for your reply. What I'm mainly wondering though, is how does trading S&P futures contracts directly influence the actual basket of 500 stocks? If there was an extremely large order on the S&P futures, there has to be an equally large order across the basket of stocks for them to move in lock step. What if there wasn't?
I know what your saying about the arbitrageurs. But I just don't understand the logic behind the futures market affecting the actual 500 stocks themselves or vice versa. Since scalpers / traders trading the lower timeframes on the ES don't actually care about the individual stocks, how does the futures trading order flow directly impacting the cash index?
Basically I think what I'm driving at is... does a large buy order of contracts on the S&P futures technically mean one is buying a tiny slice of all 500 stocks?
Or looking at it the other way round... If there was an extremely huge order to buy 'Sandisk Corp', (therefore driving up the price quote on the cash index). Would this then directly shoot up the futures price as well?... even though no contracts were traded on the futures to shoot the futures price up. Hypothetically, it was a stock in the cash market that did the rising.
Apologies for the length, I don't seem to quite understand the logic of what ties the two in terms of order flow.
This post has been selected as an answer to the original posters question
Basically the stock market and the futures market are not tied until the futures contract expires. The ES mini contract is cash settled, as it would not be practical to deliver a basket of stocks. The final settlement price is based on the prices of the component stocks.
Therefore you know that the ES contract will be exactly worth the stocks that it is built from at conctract expiry. Starting from this point you can calculate a fair value for the ES contract. To calculate the fair value you will start with the current price of all 500 stocks. Then you need to subtract the dividends that are due prior to expiry, as the holder of the ES contract does not benefit from dividend payments (this would be different for the FDAX) and you would add the interest based on the risk free rate until contract expiry, as the stock holder needs to pay the stocks while the futures contract is traded on margin.
Once the fair value of the futures contract has been calculated, this will attract arbitrageurs as soon as the price quote of the futures contract is above or below the fair value by a minimum amount. This is just an opportunity to make money. Therefore the markets move more or less in lockstep.
During a crash however - see flash crash - execution of transactions and dissemination of price quotes may suffer from a significant delay. In that case arbitrage becomes impossible, and the price differential between cash market and futures markets may increase.
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