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Futures Arbitrage - PowerPoint PPT Presentation


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Futures Arbitrage. Program Trading. Essentially a cash and carry, or reverse cash and carry, arbitrage between an index and a basket of stocks related to the index.

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program trading
Program Trading
  • Essentially a cash and carry, or reverse cash and carry, arbitrage between an index and a basket of stocks related to the index.
  • One of the confusing factors about program trading is that if the basket pays income (ie dividends) during the arbitrage period, then there will be a payment necessary if the underlying is “shorted” and a receipt if the underlying is bought.
program trading cont d

Your expectation should be:

(3/12)

F = 405 * (1.05)

= 409.97

Program Trading cont’d
  • Assume you have $10 million in credit to play with. The index is at 405, but the 3 month futures is trading for 420, while a 5% riskless rate is available.

Thus, futures are too high, so sell futures,

buy stocks, and borrow.

program trading cont d4
Program Trading cont’d
  • Difficulty is that futures is on an index with 500 stocks, and trading in 500 stocks at once is near impossible. So, use a proxy basket of 15 or so stocks and measure relation of basket with index (Beta).
  • Also, stocks are expected to pay a dividend, in total, of $12,000, across the next 3 months. As you will buy stocks, you will get the dividends.
program trading cont d5

Value

$10,000,000

portfolio

contracts

b

-------------- *

contracts, or, -------------- * .90 = 42.86

Value

$210,000

futures

Program Trading cont’d
  • If the basket beta with the index is .90, you will need: to cover the $10,000,000 in funds available. Further, you will pay:

$10,000,000 * (1.05)(3/12) - $10,000,000 = $122,722.34

in interest on the borrowings.