Hi,
Can anybody tell me the relation between Cash market and Derivative market price? I know that Derivative products price are derived from cash price. But let me clarify where my doubt is -
Suppose, SBI is trading at 310 in Cash segment, 312 in Future and say 315 CE is trading at 1 Rs at some moment.
Now lets say in next 2 mins, massive buying happened in Cash market which eats up all the seller bids till 314 and stock is trading at 314. At that moment if nobody would have bought in Future market ( assuming ), then will the SBIFUT instrument price will remain 312 or it will automatically come to 316 following the underlying? If that happens then what will happen to the sell bids placed in intermediate prices e.g. - 313 in Future market? Will those be executed? Same scenario for option also, like for 320 CE, even if no buyer buys it at 1.05, will it still increase which it should be if it follows the spot price.
Please someone clarify me.
Let me take a shot at the pricing in the Futures segment (Options have more variables so kinda hard to address in a single post).
In your case, when the Cash (i.e. Spot) price goes up all of a sudden (to 314) and Futures are trading at a discount (312), the Arbitrage funds will jump right in to grab this opportunity and bring the Spot-Futures price back to the same premium as it was before. They would be essentially buying the Futures (consuming Asks from 312 all the way to 316, including 313) while simultaneously selling equivalent quantity in the Cash market. This aggressive buying will automatically push the Futures price to 316. Most (if not all) of these transactions are automated so it’s a matter of milli seconds that the equilibrium will be restored and Future price will be 316.
At the heart of all this is the fact that at expiry both the Spot and Futures prices converge to Spot price therefore any temporary arbitrage (or gap) in the market will give opportunity to take a Cash-Future combo trade that lock in their profits- irrespective of what the expiry price happens to be.
There is this great article about Futures pricing that you might want to go through:
Hope that helps…
Cheers!
Neha (www.VRDNation.com)
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The spot price and the futures price moves in tandem, infact the futures price leads out to reflect the price expectation of traders. When there is a lot of volatility, I’ve seen the futures price trade at a discount, trade at a premium and trade equal to the spot price, all on the same day. The spot and future prices are related mathematically and they more or less follow the relation, the markets are very efficient. Read more about futures pricing here.
Hi,
Thanks for your reply. So, What I understood is for Futures and Options the prices to be go up also need to consume all the ask prices between same as cash market (Demand and Supply). It doesn’t go up or down automatically, arbritage funds algo trading may be there behind those trades. Right?
I am wondering for so many F&O stocks, for each of them so mane F&O instruments, how they manage all of them to be in equilibrium ?? Is this algo developed by NSE or respective Funds?
if the spot faced a buying, but no good buyer’s in futures
the future price will go to discount
as we regularly see spot and future both keep coming in discount and premium
like spot 310 future 312, many a times future comes below spot that’s discount
like spot 310 future 312, many a times future comes above spot that’s premium
It’s mostly algo trading that is done by Arbitrage funds; it’s virtually impossible to do this manually in this day in age.
This article might help understand how these funds work:
By the way, there are many scripts where Futures are at discount to the Spot price therefore the arbitrage is only where there is a meaningful opportunity. I remember when Infibeam was listed in F&O segment, the Futures price was WAY lower than the Cash and people were all like “what’s going on”
. A few sessions later, Infibeam fell in the Spot price and things got reasonable from there…
Anyway, hope it makes sense.
Cheers!
~Neha (VRDNation)
. A few sessions later, Infibeam fell in the Spot price and things got reasonable from there…