Estebean and patrick. Sorry for jumping in here, but I used to follow the Fair Value everyday....even did some trades based off of it.
Here is an old post of mine from the Ideas Thread...prior to the fight with Ike (took me awhile to find this). Maybe this will help explain the points you have been talking about, how you calculate them, and how they are used.
To: +Bart (6050 )
From: +Kevin Thursday, Aug 14 1997 9:27AM EST
Reply # of 15249
>>>B-witch-How come you did not cut and paste it to this thread??<<<
Hi Bart. I'll cut and paste some Fair Value posts of mine to try to save Ike some time in discussing program buying and selling.
Here I give a quick summary:
Fair Value = the actual futures less the cash index.
When this 'spread' reaches a certain level, the upper or lower bound, computer guided program trading kicks in. The reason being is that it is cheaper to own the S&P 500 futures contract and sell the actual basket of stocks (the S&P 500). Other times it's the reverse.
In this post, I teach how one can calculate the theoretical futures price on their own if they have the proper data avilable to them.
Hi Leland. You would probably be better off calulating this on the fly because it changes throughout the day (since the cash index changes throughout the day). However, you may find it difficult to find some of this info. Does your data service have this info:
SPX live pricing?
SPX dividend info (need to know future dividends til exiration)?
SPX index divisor (you need to calculae future dividends into index points)?
Yield on a risk free rate (6 month T-Bill will work)?
SPX Futures live pricing?
Here's what you do.
Translate future dividends (til the Sept 19 expiration) into S&P index points. Future dividends=$19,221.749469 (in millions approximately)
SPX divisor=7719.5781 dividends / divisors = 2.49
This is dividends in index points.
Now take the cash index 950.30 and multiply by the risk free rate.
The risk free rate is over 365 days, so (5.27% / 365 days) / 47 days til expiration = .6786% 950.3 * 1.006786 = 956.748
subtract the dividend points you calculated (2.49) from 956.748 amd you get 954.26 This is the theoretical futures price at yesterday's close.
Not sure if it's feasible for you to calculate this on your own or now, but figured I'd give you an example of the calculation.
I'm currently working on a calculation for theoretical cash and seeing what its value MIGHT be. Just started working on it...I calculate the value, but I'm trying to test its value.
This next piece should describe the rest.
After you have that number you need to calculate the upper and lower bounds. To do this, you need to account for transaction costs to either buy the entire cash index or sell it. The assumption I have is .15%. .15% of the S&P 500 total market value is $8640 [in millions] (remember, this is the assumed cost to either buy or sell the entire basket). $8640 translated into index points is $8640 / S&P500 divisor. I can't give you the divisor (I thing S&P would sue me), but the answer is 1.13 index points.
Now you take the theoretical futures value and subtract it from the actual cash nidex. 758.27 - 753.53 = 4.74. This is the FAIR VALUE. Take the FAIR VALUE and add 1.13 to it (the transaction costs in index points) for the upper bound, and subtract 1.13 from the FAIR VALUE for the lower bound.
4.74 + 1.13 = 5.87 4.74 - 1.13 = 3.61
Upper bound = 5.87 lower bound = 3.61
I mentioned ealier that you calculate the spread between the cash index and the actual futures contract... 762.00 - 755.22 = 6.78
6.78 is above the upper bound right now which is indicating computer guided buy programs. (anything below 3.61 would be a sell program).
That should explain how to calculate Fair Value for an arbitrage play, but I want to clarify something. An arb does not buy or sell the SPX when changing his position. Nobody could afford to buy thew enitire SPX basket...not even Bill Gates (sorry Bill) :-)
Instead what arbs do is buy a basket that REPRSENTS the SPX.
Currently the SPX Sep futures contract is valued @ $462,900 (futures price * $500 (which is the value of 1 point). The arb will take the % breakdown of the SPX (stock by stock) and buy the same % of the $462,900. For example, GE is 3.071% of the SPX. So the arb would buy $462,900 * 3.071% = $14,215.66 worth of GE which is almost 213 shares. They'd continue down the list and purchase each of the 500 stocks the same way. I used 1 futures contract as an example, but the arbs deal with about 100 contracts (close to $50 million alot of the time and even more). They also buy stock in round lots, so their basket is slightly different than thre SPX but not by much.
I hope this is an opening for discussion on computer trading. Maybe Ike will comment now and add his thoughts / teachings.
Take care. |
