Best Thread Index futures correlation to underlying stocks.

[blash]

I was wondering if someone could explain or recommend some good reading, on how the futures price of say the Dax relates to the underlying stocks.

As I understand it the Dax futures price is a derivative of the Dax Index which in turn is a calculation of the 30 stocks in that index?

 

[stevet]

the dax underlying cash is based on the underlying value of the companies in the dax at any given momen - but the only way to trade that would be to physically buy those shares in the right proportion


so someone came up with a contract that allows you to buy those shares in one go - and that is a futures contract

you can buy baskets - but they effecticly just follow futures, but with less leverage

because with a futures contract you dont get dividends on the shares and because of the difference in the payment timing - there are a bunch of other valuing issues as well - but those valuing issues are finite and produce a mathematically correct price for the dax futures at any given point and the difference between the dax underlying and the dax futures is called fair value

but because people trade the futures itself - it can and does move independent of the cash as traders load up with the futures contract to precipitate moves - or if a large bank is gonna buy shares for a customer that will move the cash index, that bank with buy futures first to give a little bonus to buying the stocks that make up the index - a one way ticket for the bank and also for any trader who spots that activity

you will find stuff about fair value on most exchanges - but the part they never get into is the dirty stuff related to trading - just the mathematical stuff

 

[blash]

Well its the dirty stuff I'm after.

Is it advisable then for a Dax futures trader to pay attention to the fair value and/or activity in the underlying stocks?

 

[stevet]

you have to be real careful about trying to trade the futures by using the cash movement - and by extension - fair value - since you are getting the information late - so whatever you see in the cash has already been priced into the futures - but average fair value will give you an indication of the over-riding trend for the day

you really just need to use the futures pricing and remember that every single tick is telling you something - the dax is volatile in relation to range movements - but not that noisy - so is one of the best to trade - especially if you understand its inter-market relationship to the nasdaq - and also its open a long time - so there are other interesting opportunities relative to the breaks the traders in companies take in Europe

 

[blash]

stevet,

Would you mind expanding a little on these 2 points.

1. the dax is volatile in relation to range movements - but not that noisy

2. understand its inter-market relationship to the nasdaq

Cheers

 

[stevet]

this stuff is real complex and is also what real trading is about - as opposed to trend lines and rsi mumbo jumbo - have a look into it, try to get your head around it - and if you really get stuck on specific points - send me a message and i will try to help - but you gotta do some work

but the range point is simply that markets are constantly moving - and the more they move - the more that there are little moves that can confuse the market direction - something like the S&P has a lot of little "confusing moves" relative to its overall range extensions - but even relative to the estoxx - the dax is much cleaner

 

[blash]

Well I'm with you on trend lines and rsi etc mumbo jumbo.

Never liked them or traded with them successfully, always too far behind the action for me.

 

[stevet]

rsi is a waste of time - but i am not saying 100% that all TA is a waste of time - just that it is only a small part of a real big picture and its only the people who arnt traders who try to focus on TA the key to trading

 

[JumpOff]

Hi Stevet (et. al),
I am hoping you can explain this is more detail. I know that in the above message you were talking about the DAX, but I assume the same holds true for the SPX and E-mini S&P? Is it your understanding that the price on the futures moves the underlying cash index?

you have to be real careful about trying to trade the futures by using the cash movement - and by extension - fair value - since you are getting the information late - so whatever you see in the cash has already been priced into the futures - but average fair value will give you an indication of the over-riding trend for the day

When I traded commodities, I saw the cash price of ag supplies 'pulled' in the direction of the futures price by arbing . but...
The cash/spot/fair value SPX doesn't go up because of buying pressure on SPX / ES futures contract, does it? It goes up because the arbitrary mathematical formula that generates it recognises that the underlying stocks have gone up, right?

Here it is from the horses mouth:
Quote:
http://www.cboe.com/OptProd/indexopts/spl_spec.asp
The Standard & Poor's 500 Index is a capitalization-weighted index of 500 stocks from a broad range of industries. The component stocks are weighted according to the total market value of their outstanding shares. The impact of a component's price change is proportional to the issue's total market value, which is the share price times the number of shares outstanding. These are summed for all 500 stocks and divided by a predetermined base value. The base value for the S&P 500 Index is adjusted to reflect changes in capitalization resulting from mergers, acquisitions, stock rights, substitutions, etc.

Boy, I sure hope I've got this wrong. My head is starting to hurt with everyone talking about how the action on the futures "causes" the price of the index to change. (I've asked this question on other areas of this board and I'm still really confused. - going to go get a strong hit of caffiene now..) Isn't that like saying the action of people betting on the horse "causes" it to run faster or slower in the race??
JO

 

[stevet]

mmm - interesting/depressing that this topic was going on a year ago and i have some arrogont learners on another thread now, who dont know diddly, telling me i am wrong about what is a very simple and basic part of trading

to trade the S&P 500, you have to use futures or etfs or a parcel of stocks of all the constituents of the S&P500, or a parcel of a smaller number of stocks that reasonably replicate the S&P500

but the reason you are doing it is to make money and futures give high leverage and transparancy - and because of that, the best traders are going to be using them to make a lot of bucks each day

as the traders are trading the futures contract - the contract will move up and down or sideways with their sentiment and needs - but the consensus of these traders do the exact right thing at any given moment - even if that changes every moment - so effectivly, the futures are always going to lead the cash index, since these traders are always one step ahead, so if you trade off the cash index - and not the futures - you are always gonna be that bit behind

there are an awful lot more technical and trading reasons why you would definetly not want to use the cash index and a lot more reasons why you would want to use futures to guide you - but regardless of them - the simple fact outlined above - if you think about it - should be enough to get you straight

if it isnt enough- dont trade until it is - or you are going to be dumping money left right and centre

dont worry about what is happening with the cash index - your bet is riding on the futures - so screw the cash index - forget all about it

 

[AlexAndrews]

A Little Substantiation

the dax underlying cash is based on the underlying value of the companies in the dax at any given momen - but the only way to trade that would be to physically buy those shares in the right proportion


so someone came up with a contract that allows you to buy those shares in one go - and that is a futures contract

I suspect that I'm one of those "arrogont [sic] learners on another thread". Perhaps you could quote a source (a link to the relevant page on the LIFFE website, maybe) that substantiates your claim above that buying an index future contract results in shares of that index being bought in the stock-market.

TIA

Alex