Trading the Basket and the Sectors

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From a trading desk, a loud voice screams, "Sell the stocks and buy

the futures!" Later in the day that same voice announces, "Buy the

futures and sell the stocks!" With the push of a button, a basket of

hundreds of stocks are sold in the blink of an eye. This is a game that

is played by portfolio managers and arbitrageurs every day in an attempt to balance the risk of their positions and to profit by the

move. Based on what they believe fair value to be and the premium

or "spread " they buy undervalue and sell overvalue. Fair value is simply

the value of the S&P 500 plus interest paid minus all dividends. If

the futures price is to o high relative to the present index value arbitrageurs

and others can buy diversified portfolios of stocks of large

companies and sell equivalent amounts of overpriced stock index

futures. The reverse can be accomplished by pushing the sell button.

In most cases, human beings are not pushing the buttons to buy

sell. or Computers ar e buying and selling based on a valuation program.

This is what 1* referred to as program trading or index arbitrage.

This selling and buying moves the market, specific stocks, and

sectors. A short-term trader can take advantage of this massive buying

and selling.

Before the market opens, a trader using the basket strategy

would find out if the futures were trading at a premium or a discount.

This will give the trader an idea of market trend direction for

a short period of t i m e.

From a trading desk, a loud voice screams, "Sell the stocks and buy

the futures!" Later in the day that same voice announces, "Buy the

futures and sell the stocks!" With the push of a button, a basket of

hundreds of stocks are sold in the blink of an eye. This is a game that

is played by portfolio managers and arbitrageurs every day in an attempt to balance the risk of their positions and to profit by the

move. Based on what they believe fair value to be and the premium

or "spread " they buy undervalue and sell overvalue. Fair value is simply

the value of the S&P 500 plus interest paid minus all dividends. If

the futures price is to o high relative to the present index value arbitrageurs

and others can buy diversified portfolios of stocks of large

companies and sell equivalent amounts of overpriced stock index

futures. The reverse can be accomplished by pushing the sell button.

In most cases, human beings are not pushing the buttons to buy

sell. or Computers ar e buying and selling based on a valuation program.

This is what 1* referred to as program trading or index arbitrage.

This selling and buying moves the market, specific stocks, and

sectors. A short-term trader can take advantage of this massive buying

and selling.

Before the market opens, a trader using the basket strategy

would find out if the futures were trading at a premium or a discount.

This will give the trader an idea of market trend direction for

a short period of t i m e.