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Spot/Futures Parity - should it matter?
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Spot/Futures Parity - should it matter?

  #1 (permalink)
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Spot/Futures Parity - should it matter?

Hi guys, have a question with regards to spot-futures parity, with particular reference to how HFTs trade and how we should be reading Futures Tick Charts and Market Deltas.

I understand that HFTs and the like keep Spot-Futures price moving in tandem. Hence, what is the significance of non-time/price related charts (Tick Charts, Volume Charts) given that HFTs are the ones keeping the market in balance?

To rephrase the question in a simpler manner, why should we be concerned with the Ticks and Volume of futures contract when we know full well that HFTs are the ones that ensure parity between Spot and Futures?

Does the Spot Market lead the Futures market or vice versa? I understand that this is pretty much a chicken and egg situation. In order to capitalise on arbitrage opportunities, (if I understand it correctly) HFTs will transact on both Futures and the Spot market to earn riskless profit.

My question may be a little confusing, but I am truly curious about how we as traders place so much emphasis on volume and market delta trading the Futures contract when all we could be doing is reading through a false veil as what drives the Futures Contract is actually the Spot Market. Another example is how a "stop-run-breakout" occurs. Are the stops actually placed on the futures market or the spot market for the actual "stop-run" to occur?

Of course, this "problem" applies to mainly the Forex and Equity Futures. I am not sure if it applies as much to something like CL or other commods since I am not sure if a spot market does exist for those.

Well, it is something I have been pondering about whenever I trade, wondering about which market leads which, does volume at the bid/ask correspond to the actual volume on the spot market, should I be concerned about a TON of contracts being traded at a price and yet the price does not budge (is it a huge buyer at the Spot or Futures).

Any comments will be welcomed. I definitely do not need an answer - I still will use Tick Charts and a little reading of Delta and the like to trade my 6E. Thanks!

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  #3 (permalink)
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For equities the futures market is much faster to react than the spot market. Index futures lead the spot market. THe same applies to interest rate futures.

For currencies the reverse should be true, as the size of the FOREX markets is a large multiple of the futures markets.

This does not invalidate technical concepts in trading. Whether order flow is driven by news or by arbitrageurs, does not make a large difference, unless you are in engaging in HFT trading yourself.

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Thanks for the reply Fat Tails. I was just thinking about order flow with respect to Forex futures. If the Forex spot leads futures, then surely all the HFTs out there will be interested in is to create a market between the bid ask (in the futures MKT) and not be interested in hitting the market whenever price moves (in the spot).

Thus taking this to the logical conclusion, all orders that get filled in the futures market are either human trader orders or HFTs that have lagging orders that did not pull itself off the market fast enough and got hit by other HFTs which perform better.

I know my argument may be too simplistic in defining what a market is, but if the gist of it is true, isn't order flow in the Forex futures market a lagging indicator as what we should be focusing on is actually the spot market order flow?

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Futures are a derivative of 500 stocks

Don't forget that for US Equity futures, like ES:

1) The S&P 500 is an average of the 500 stocks it tracks
2) The ES is a futures product of the S&P 500 index

So, isn't it the 500 individual stocks that are the most important drivers of the S&P 500 index and the ES? I mean, just because "Number 1" in the S&P pits is buying paper hand over fist, at some point all of those 500 stocks prices will need to move as well, and I don't think HFTs or anybody else is going to buy all 500 stocks just to keep the futures in line with the individual stocks prices, but it wouldn't surprise me if that was the case. I'm just saying, I don't believe the futures move the markets as much as when the 500 stocks are moving the index and it derivatives have to fall in line. In the end, I guess I believe that the aggregate sum of buying/selling force in each of the 500 stocks exceeds the buyers/sellers in indexes and futures, but I could be wrong.

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shodson View Post
Don't forget that for US Equity futures, like ES:

1) The S&P 500 is an average of the 500 stocks it tracks
2) The ES is a futures product of the S&P 500 index

So, isn't it the 500 individual stocks that are the most important drivers of the S&P 500 index and the ES? I mean, just because "Number 1" in the S&P pits is buying paper hand over fist, at some point all of those 500 stocks prices will need to move as well, and I don't think HFTs or anybody else is going to buy all 500 stocks just to keep the futures in line with the individual stocks prices, but it wouldn't surprise me if that was the case. I'm just saying, I don't believe the futures move the markets as much as when the 500 stocks are moving the index and it derivatives have to fall in line. In the end, I guess I believe that the aggregate sum of buying/selling force in each of the 500 stocks exceeds the buyers/sellers in indexes and futures, but I could be wrong.

When fear and volatility are rising, it is easier to hedge long stock positions with futures. Also the futures market is more liquid. The October crash in 1987, saw futures about 7% lower than its component stocks. During the flash crash the differential that was observerd was only 1%. This suggests that arbitrage has been facilitated by technology, as it has reduced the lag that stocks usually show compared to the futures.

More is here:

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Spot/Futures Parity - should it matter?-marshall-e.-blume-.craig-mackinlay-bruce-terker-order-imbalances-black-monday-1987.pdf   Spot/Futures Parity - should it matter?-aaron-carlton-flash-crash-effects-s-p-500-index-stocks.pdf  
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futures are in the future

Cash/ spot are today.

They are different things ?

Yeh people have models that say the difference should be the cost of carry but they are just that, models. One context / situation can mean one thing and another something else....

There are no rules, that this is that, so that should be that etc etc

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Itsjustamarket View Post
futures are in the future

Cash/ spot are today.

They are different things ?

Yeh people have models that say the difference should be the cost of carry but they are just that, models. One context / situation can mean one thing and another something else....

There are no rules, that this is that, so that should be that etc etc

Yes they are different instruments altogether. However we must recognise that if there is a difference in the movement (not absolute price), there will be an opportunity for arbitrage (riskless trade), which is what HFTs do to ensure that futures and spot move in lock step.

My original question was actually querying the consequence of having lock-step movement. If we assume that the HFTs are programmed to ensure that arbitrage is impossible (ie, they are fast enough to mitigate all difference in price), then why are we studying the delta of the FUTURES contract when we trade? As HFTs are the main liquidity providers in the market, and we assume that the HFTs moves their bid/ask almost instantaneously, won't this mean that orders that are hit in the Futures contract are actually lagging orders and is not good reference to determine future price movement.

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strikebackfast View Post
Yes they are different instruments altogether. However we must recognise that if there is a difference in the movement (not absolute price), there will be an opportunity for arbitrage (riskless trade), which is what HFTs do to ensure that futures and spot move in lock step.

My original question was actually querying the consequence of having lock-step movement. If we assume that the HFTs are programmed to ensure that arbitrage is impossible (ie, they are fast enough to mitigate all difference in price), then why are we studying the delta of the FUTURES contract when we trade? As HFTs are the main liquidity providers in the market, and we assume that the HFTs moves their bid/ask almost instantaneously, won't this mean that orders that are hit in the Futures contract are actually lagging orders and is not good reference to determine future price movement.

Whether futures contracts are driven by futures traders or the underlying does not matter. If you trade futures you trade both the cash market and the futures markets at the same time. Usually both markets move in lockstep.
However, for the S&P 500 arbitrage is not so easy, as perfect arbitrage would involve buying or selling a basket of 500 stocks. Therefore arbitrageurs might rather trade a few liquid stocks representing a major share of the market capitalization of the S&P 500.

Also there are temporary imbalances, in particular when stock options expire or during the last business day of the month. In those case index futures may deviate from their fair value. I have observed this a few times, in particular during the last minutes of regular trading. Arbitrage is not easy then, as you may not get full execution on the stock market, which is set to close at 4:15 PM EST.

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Fat Tails View Post
Whether futures contracts are driven by futures traders or the underlying does not matter. If you trade futures you trade both the cash market and the futures markets at the same time. Usually both markets move in lockstep.
However, for the S&P 500 arbitrage is not so easy, as perfect arbitrage would involve buying or selling a basket of 500 stocks. Therefore arbitrageurs might rather trade a few liquid stocks representing a major share of the market capitalization of the S&P 500.

Also there are temporary imbalances, in particular when stock options expire or during the last business day of the month. In those case index futures may deviate from their fair value. I have observed this a few times, in particular during the last minutes of regular trading. Arbitrage is not easy then, as you may not get full execution on the stock market, which is set to close at 4:15 PM EST.

@Fat Tails, as I am a 6E trader, I was actually referring to what I said above in the forex futures market. Would your reply change given the above? I see your point that spot/future arbitrage for the ES may be very complicated, but would that apply to the EUR/USD - 6E?

Your point in equities arbitrage is well taken.

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