Q&A

I am from Argentina and I work in a proprietary firm. I have some questions about the premium index. First, is the premium Standard & Poor's 500 futures - S&P 500 cash index or is S&P 500 futures - S&P 500 cash index + FV spread? I understand that the premium is S&P 500 futures - S&P 500 cash but in the web of my broker, you see that premium is S&P 500 futures - S&P 500 cash index + FV spread. Which is correct? Second, do you use only premium when breaking program levels?--Sheik

Both your definitions are correct. Certain data vendors use the Prem symbol for the difference between the spot price of the S&P 500 index and the S&P futures. Our traders consider fair value in our Prem equation. We take the spot price + estimated fair value (which is basically a cost of carry calculation based on interest rates and time until expiration of the futures contract), plus or minus the futures price).

And here's something from H.L. Camp's website, www.programtrading.com: "FV is nothing more than the value of S&P 500, plus the interest I pay my broker to buy all of the stocks in it, minus all of the dividend checks I get from those stocks."

And here's another definition:

`FV = S [1 + (I - D)]`

"S" is the S&P 500.  The ticker symbol is Spx and/or Inx on most good datafeeds <www.programtrading.com/datafeeds.htm>. "I" is the amount of interest paid to your banker or broker to borrow the money to buy all of the stocks in the S&P 500. The interest is calculated based on a percentage lending rate (R) from the current date (today) until the date that the S&P futures contract expires in March, June, September, or December.

"D" is the amount of dividends paid from the companies that you own in the S&P 500 that pay a dividend. The dividends are paid to you based on the record dates for any stock in the index that is announced between the current date (today) and until the date that the S&P futures contract expires in March, June, September, or December. This dividend income is expressed as a percentage rate too.

The latter (premium or discount adjusted calculation using FV) is useful in determining the estimated opening range of the overall market prior to each day's opening bell. We use that up/down percentage for the pricing of our opening-only orders on the Nyse stocks each morning. If the futures indicate that the overall market will be opening up 1%, then we make an assumption that each of our stocks should open up 1% and place our bids and offers around that price. If the stock opens further up, or further down than our bid/offer, we feel comfortable in knowing that we are participating in the opening gap on the same side as the Nyse specialist. This opening play has been detailed here in Technical Analysis of STOCKS & COMMODITIES.

We also use the Prem/Disc (discount) of the futures to the adjusted spot + FV number to help with our intraday entry/exit determinations. If we see a large premium, then we know that the futures traders, who are selling the futures, will likely be buying the underlying securities to hedge themselves, basically buying at parity and selling futures above parity. This gives us time to anticipate intraday market swings.

HERE'S THE FUTURE

My question is in regards to the S&P futures movement from 4 pm to 4:15 pm. This period is after the regular market closes, so what is the futures movement based on? Is it market on close orders getting finished and after market company results announcements, or is it other factors -- can you explain this?

Is it better to set an emini futures chart to the time frame of the regular stock market hours of 9:30 am to 4 pm or until 4:15 pm, when the futures pit closes? I ask because when measuring the size of the gap between the close and the morning, is it better to disseminate after market activity or keep it set to market hours for a true reflection?

You also referred to the preopen in how brokers hedge themselves in the morning when they get sent buy orders in from institutions, so they buy the eminis to hedge themselves against the upcoming buy orders of stock. --Raker

We use the 9:30 am to 4 pm for the actual trading day of the futures for analysis purposes, and keep trading after 4 pm if we see an opportunity to profit and/or close positions. Some trading starts again at 4:30 pm (Globex), but most traders don't trade overnight. I use the Chicago Mercantile Exchange "open, high, low, close" numbers for determining the next day's pivot points and other analysis.

And yes, this time frame allows for hedging the market on close equity orders that get filled a couple of minutes after the markets close at 4 pm. This also allows for trading based on news/earnings and so forth that are announced right after the 4 pm bell and gives traders a bit of time to flatten out daytrades.

Regarding the preopening: Some brokers who have large orders to buy stocks on the opening tend to buy futures in the premarket (not hedge) with the feeling that with all those buy orders, the market will likely gap up so they can make a profit on the futures to augment their profit from supplying stocks. Hope this helps.

E-mail your questions for Bright to Editor@Traders.com, with the subject line direct to "Don Bright Question."

Originally published in the July 2007 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2007, Technical Analysis, Inc.