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Hi Guys, A problem that has been keeping me awake is that if the S&P is a function of the price of 500 shares but the E mini is a traded future, what is it that keeps them from diverging?
Cheers
Arbitrage.
Ok, so if the Arbitrage dealers are keeping it in line with the s and p then what price movement effect do the institutions have or does it just follow the s and p?
Institutions buy or sell based on all kinds of reasons which we'll never know. They may use stocks, ETF, futures or options. Whatever instrument anyone trades in bulk will move. Once that instrument moves, all the correlated ones will also move due to portfolio rebalancing or arbitrage. Sometimes the ETF will move first and futures will catch up, sometimes the futures will move first.
If an institution suddenly buys billions of dollars worth of SPY, then SPY would move first before the underlying stocks have had a chance to move. But the SPY being the ETF, it will have to balance its portfolio, so it would automatically buy the contistuent stocks based on its algorithm. This would move the stocks. In the meantime ES would also catch up due to arbitrage.
Thanks a million for the detailed reply. That makes a lot of sense.
