Just another day @ the FED

[Jim Nickerson]

Re: Just another day @ the FED

Any significant differential between the future price and the current price creates an arbitrage opportunity.

If I can buy today at 850, and simultaneously sign a contract (on the futures market) to sell next week at 900, then I can make a guaranteed return on my money.

Hence if the S&P future price moves up substantially, the S&P itself will tend to follow pretty closely.

I assume, perhaps incorrectly, that if you guys are writing something that isn't clear to me, that it probably isn't clear to someone else also--maybe many others.

When you say "buy today at 850," exactly for what are you paying money to own?

Also, do you mind explaining this "I can make a guaranteed return on my money."

I've yet to find any guarantees of making money in anything having to do with any markets anywhere, anytime.

[grizam303]

Re: Just another day @ the FED

I assume, perhaps incorrectly, that if you guys are writing something that isn't clear to me, that it probably isn't clear to someone else also--maybe many others.

When you say "buy today at 850," exactly for what are you paying money to own?

Also, do you mind explaining this "I can make a guaranteed return on my money."

I've yet to find any guarantees of making money in anything having to do with any markets anywhere, anytime.

I assume he means buying ETF shares on the cash market today at 850, with the option to sell them at 900 in a week. Even if market price drops, he can still sell at 900, guaranteeing a profit. However, I doubt that these kinds of spreads occur, since even a small spread would quickly be turned into a similar profit with a much smaller magnitude.

[laphroaig]

Re: Just another day @ the FED

I assume he means buying ETF shares on the cash market today at 850, with the option to sell them at 900 in a week. Even if market price drops, he can still sell at 900, guaranteeing a profit. However, I doubt that these kinds of spreads occur, since even a small spread would quickly be turned into a similar profit with a much smaller magnitude.

grizam303 has understood correctly, though I imagine that the arbitrageurs who do this for a living have access to rather more exotic instruments than the ETFs you or I might trade in. Bottom line, they are buying real stocks that comprise the S&P500, having already committed to selling them in the future at a higher price.

I agree these kind of spread I used in my example isn't going to occur in reality. As soon as the spread widens beyond overnight money market rates, I'd expect arbitrageurs to start making these trades, bringing the real S&P back in line with the futures.

[laphroaig]

Re: Just another day @ the FED

Additional point perhaps worth making. These trades are not likely done by actual people spotting differences and trying to make trades.

All the major banks have arbitrage departments, who write computer software that monitors the different markets for arbitrage opportunities such as this and make the trades automatically.

Whoever has the fastest computers gets to make the money on the gap that's opened up in the market. There's a pretty much never-ending arms race to get fastest software and hardware that can spot these opportunities and squeeze out the money faster than anyone else.