market open. Remember that there is also the time value to consider
here (i.e., convergence). You would now be one day closer to maturity
than the day before so the elapsed time is also a relevant factor in all
Now you may be tempted to try to get in on the action by jumping
in the market and gobbling up some stocks at the open. And I would
say, good luck. The average investor rarely can take advantage of this
imbalance for two reasons. First off, you can't possibly buy enough of
all the 500 stocks on the S&P 500 that fast (and if you could the
commission would be hefty). Second, the rise in the S&P futures is
pretty much immediate, leaving no chance for the individual investors
to get in on the action. Who can buy so many stocks that fast? Large
institutions for one, and all the trades are driven by computers which
automatically kick into action every morning based on the S&P futures.
When the S&P futures are above fair value, the computers buy stocks
and sell futures until the balance is reached and S&P futures are once
again stand at fair value.
The same situation applies when the S&P futures are below fair value
(known as discount to fair value), only in reverse. In this case the
computers sell stocks and buy futures until S&P futures stand at fair
value. Meaning an immediate dip for the stocks at the open.
If the S&P futures happen to stand exactly at fair value at the market
open, nothing would happen as far as programmed trading. There is no
theoretical difference between S&P futures and cash when the futures
are at fair value.
You may also have heard of the terms premium to cash and discount
to cash. These terms are used when the value of the S&P futures are
compared to cash rather than fair value. As the maturity date nears for …