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1.
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Definition
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Index
arbitrage is a subset of statistical arbitrage focusing on index
components.
The idea is that in an index (such as S&P 500) is made up of several
components (in the example, the Top 500 US biggest firms by market
capitalization) that influence the index price in a different
manner.
For instance, there are leaders (components that react first to
market impact) and laggers (the opposite). As the index is the
weighted sum of all components, identifying leaders and laggers can
provide a proprietary trader can take position in these to make
money if he believes the laggers will eventually rally on the
leaders. The challenge being of course to correctly identify these,
and have the technology to act on the market place before the price
correction takes place.
Other Resources:
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National Futures
Association:
The simultaneous purchase (sale) of stock index futures and the
sale (purchase) of some or all of the component stocks which
make up the particular stock index to profit from sufficiently
large intermarket spreads between the futures contract and the
index itself.
More…
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Environmental Investors:
A trading technique in which baskets of stocks and stock
futures contracts are bought and/or sold according to their
conformity and deviation from a stock index.
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Share Analysis:
An investment strategy that exploits divergences between actual
futures prices and their theoretically correct prices in order
to make a profit.
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WR Hambrecht + Co.:
Trading in order to profit by temporary differences between the
value of stocks in an index and the price of the future contract
for a derivative index.
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Citibank:
Buying or selling baskets of stocks while at the same time
executing offsetting trades in stock-index futures.
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Palgrave MacMillan:
A strategy which aims to make a profit at any significant
departure of stock exchange futures prices from their
theoretical values.
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Advanced Financial Network:
An investment trading strategy that exploits divergences
between actual and theoretical futures prices.
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ANZ.com:
An investment or trading strategy which attempts to
maximise
returns
by shifting between
long
and
short
market
positions
and buying and selling share-price
index
futures
contracts.
More…
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2.
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Examples, Types, or
Variations
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Index
Arbitrage programs consist of:
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Sell Programs
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Buy Programs
Other
types of index arbitrage include basis trading, the arbitrage
between a current index value (synthetically replicated) and that of
its future.
Other Resources:
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SmartMoney.com:
For example, if stocks are temporarily cheaper than futures, an
arbitrageur will buy stocks and sell futures to capture a profit
on the difference, or spread, between the two prices.
More…
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Professor David Eagle
Eastern Washington University
Index Arbitrage - Two Markets:
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Stock
market (an index of stocks, e.g., S&P500)
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The spot or current market
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Stock-index futures market
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Futures on a basket of stock
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Example: S&P 500 stock index futures.
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3.
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Formula
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Other Resources:
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Stanford University:
Index Arbitrage:
A futures contract is designed to predict the price of a stock
market index at some later date. Whether it is a bond or a bank
account, a simple formula predicts the future value of any
financial instrument:
F =
S(1+r)^t
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4.
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Related Terms
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5.
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As
Used in the Hedge Fund World
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Other Resources:
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Index Arb:
Index
arbitrage is a form of program trading activity that can produce
sudden and possibly sharp market movements.
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Electronic Journal of
Business Ethics and Organization Studies:
Similarly, the objective behind index arbitrage is not to
maximize profits ad infinitum but rather to lock in a
modest risk-free return. This is achieved by exploiting the
'spread' between the value of a futures contract and the
corresponding spot value.
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6.
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Applications
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Other Resources:
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Index Arb:
Knowledge of the price of an index future and its associated
spot index relative to each other can be indicative of future
index arbitrage program trading activity, which can in turn can
produce sudden and sharp market movements.
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7.
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Misused
& Abused
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Other Resources:
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Finance Gates:
Like all
arbitrage
opportunities, index arbitrage opportunities disappear rapidly
once the opportunity becomes well-known and many investors act
on it.
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8.
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Additional Sources of Information
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Books
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News
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Scholarly Papers
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Back to Terms
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