How Arbitrage Links S&P 500 Futures and the Cash Index
Summary
The document explains how trading in S&P 500 futures can be connected to movements in the cash index, even though a futures trade does not directly sell shares in the index constituents. Futures are marked to market daily and ultimately settled against the underlying price at a future delivery date. A theoretical futures price can be inferred from the spot index and short-term interest rates, with expected dividends also relevant to the adjustment.
When futures and their implied no-arbitrage value diverge beyond trading costs such as bid-ask spreads and slippage, arbitrageurs may trade the futures and the replicating cash exposure. Those trades can transmit pressure between markets and help keep prices aligned. The response also notes a distinction between futures and forwards: daily margin cash flows create convexity differences because forwards generally settle at delivery. The discussion gives a conceptual mechanism, not a quantified account of how a particular order moves constituent stocks or an estimate of the relationship's strength.
Key ideas
- A futures price is related to the spot index, financing rates, and dividend expectations.
- Daily marking to market distinguishes futures from forwards and can create a convexity difference.
- Arbitrage between futures and replicating cash exposure helps align prices when deviations exceed trading costs.
- Futures orders can affect the cash market indirectly through arbitrage activity rather than direct constituent share sales.
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# Relationship in Order Book between S&P500 and S&P500 Futures Contracts # Relationship in Order Book between S&P500 and S&P500 Futures Contracts What is the relationship between E-mini SPX futures and the SPX index. Besides the obvious, one is cash the other is a futures product. How does buying/selling in one product influence the other. If someone sells 1000 contracts of E-mini futures how does that affect the S&P500 Index?? The trade he made should only affect the futures market. The seller isn’t technically selling shares in each individual stock within the SP500, so how does the cash market adjust to the sell order within the futures market?? ## Answer by BlueTrin (score 1, accepted) https://quant.stackexchange.com/a/9323 In general futures are contract which are marked to market everyday and are settled against the cash/underlying price at a future delivery date. For the SPX, I think there are only deliveries in Mar, Jun, Sep and Dec. In theory, one can calculate the implied future price using the short rates and the spot price. One thing to note is that there is a convexity between forwards and futures as the future margin calls are done on a daily basis, while the forward does not exchange cash until delivery. So basically, even though one does mot know what will be the price at delivery date, you can imply a non arbitrage price from the spot and short rates. This is what forces the spot and future to move somewhat in the same direction. Like with any product which can be replicated, if the price deviates by more than the bid-ask + slippage from the theoretical price, one will try to arbitrage the difference. I bumped into this interesting link which mentions the dividends adjustment.
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.