A stock index futures contract binds two parties to an agreed value for the underlying index at a specified future date. Nothing is guaranteed, however. For example, if news creates demand for a futures contract, but short-term traders overplay it, then the basket of underlying stocks, the index, does not move. This action is known as price discovery. The more components of the index, the greater the chances of some of them being mispriced, and the greater the opportunities for arbitrage. When index futures prices deviate too far from fair value, arbitrageurs deploy buy and sell programs in the stock market to profit from the difference. Index arbitrage is a trading strategy that attempts to profit from the price differences between two or more market indexes. Fair value can show the difference between the futures price and what it would cost to own all stocks in a specific index. This is the basis for the calculation of futures fair value and of the arbitrage that keeps futures markets trading in line with the index. The presence of index arbitrageurs is an argument for active investment which is less vulnerable to this exploitation (but however incurs higher management fees) or for simple buy and hold strategies. If S&P 500 Index futures move higher outside of market hours and suggest the stock market will rise on the opening, investors who wish to sell that day may want to wait until after the market opens before entering their order (or set a higher price limit). Just because index futures have a fair value doesn't mean they trade at that price. A must be filled (MBF) order is a trade that must be executed due to expiring options or futures contracts. No matter what the situation is, the strategy will include buying the relatively lower-priced security and selling the higher-priced security with an expectation that prices should return to equivalence. In addition, the arbitrageur may improve the arbitrage profit by adopting the so-called early unwinding strategy of … Trading is typically volatile at the opening bell on Wall Street, which accounts for a disproportionate amount of total trading volume. During 2008 and 2009, it must have been a risk, as companies slashed dividends - this would have been murder for index arb desks, who are generally long stock, short futures … This is equal to the cash, or spot price, after taking into account compounded interest and dividends lost because the investor owns the futures contract, rather than the physical stock itself, over a specific period. The local equity markets will probably rise, and investors may anticipate a stronger U.S. market, too. Example 1: Arbitrage Free Price of a Stock Index Future. • Index has a base date of April 01, 2010 and base value of 1000. An investor in index futures does not receive (if long) or owe (if short) dividends on the stocks in the index, unlike an investor who buys the component stocks or an exchange-traded fund that tracks the index. This kind of arbitrage is most often employed by large financial institutions with the resources necessary to capture many fleeting disparities. Index futures do predict the opening market direction most of the time, but even the best soothsayers are sometimes wrong. The witching hour is the final hour of trading on the days that options and futures expire. So, a future contract's fair value is the amount at which the security should trade. The S&P 500 index arbitrage is often called basis trading. The rise or fall in index futures outside of normal market hours is often used as an indication of whether the stock market will open higher or lower the next day. Buyers may want to hold off when index futures predict a lower opening, too. 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