The Hidden Risks of Index Trading

SPX and S&P 500 futures don’t always move up and down together. Which one should you look at if you want to know what the market might be doing? chocolate one vanilla piece of cake on two respective white raised platters
3 min read
Photo by Dan Saelinger

Key Takeaways

  • Why the SPX and S&P 500 futures aren't perfectly correlated
  • If you trade SPX options, keep an eye on the S&P futures
  • S&P 500 futures may be telling you more about what the market might be doing

Back when “the market” was just stocks, some genius came up with a way to figure out what all the stocks (at least the popular ones) might be doing overall. Behold, the equity index! Whether it’s price-weighted like the Dow Jones Industrial Average, or capitalization-weighted like the S&P 500, an index is just an average of stock prices. And when the stock prices change, the index value changes. Simple—and useful.

How Indices Work

Indices turned out to be popular, and they spawned all sorts of products like index options and index futures. Those are handy when you want to speculate on an index’s direction. Fire up your thinkorswim® platform from TD Ameritrade and have a look.You might have /ES (the S&P 500 future) and SPX (the index on the S&P 500) loaded up on a watchlist. Because they’re both based on the S&P 500 index, you figure when one moves up, the other should, too, by the same amount. But they don’t—at least, not always. How come?

There are 500 individual stocks that make up the SPX. Many of these stocks may trade actively, with transactions occurring every second. Others may trade less frequently—every few seconds, or few minutes. Here’s where it gets interesting. The SPX changes when the last trade price of any component stock changes. Meanwhile, the stock’s bid and ask prices might be above or below the last trade price, and more accurately reflect its current value. But until that stock trades, the SPX’s value doesn’t change. So, it doesn’t necessarily reflect the current value of all 500 stocks. The SPX, then, is a snapshot of the last trade prices. 

The /ES future, on the other hand, is its own product, and isn’t tied directly to the S&P 500 stocks. That means the value of /ES is determined by buyers and sellers of the futures contract. If traders think the S&P 500 will rally, they’ll buy /ES and drive its price up. The price of /ES doesn’t have to wait until all 500 stocks trade. If /ES traders think a stock that hasn’t traded yet has a higher or lower price, they’ll adjust their /ES trades accordingly. When traders look for arbitrages between /ES and basket of 500 stocks, they look at the bid and ask prices of the stocks, and not their last trade prices.

This is why SPX and /ES don’t always move up and down together, tick by tick: the SPX changes only when one of its stocks trades, but /ES can change anytime. The arb relationship means when one makes a big move up or down, the other does, too. But when there isn’t much movement in the market, you may see /ES move up and down more actively than SPX. You may also see /ES move up or down quickly, and then a few seconds or minutes later, SPX catches up. And this is important if you’re trading SPX options, because SPX options are priced off /ES prior to expiration.

Why Pay Attention to /ES?

A trader who’s bullish on the S&P 500 might consider selling a put on the SPX options. Say you’re looking at a particular put, and notice SPX hasn’t changed, but the put’s price has dropped. Why? Possibly because the “market” believes the S&P 500 might go up and is pushing up the price of /ES. But all stocks in the SPX haven’t traded yet. That SPX put is looking at the /ES, not the SPX. And if you want to know what the market’s doing, you might consider looking at /ES, too.


Key Takeaways

  • Why the SPX and S&P 500 futures aren't perfectly correlated
  • If you trade SPX options, keep an eye on the S&P futures
  • S&P 500 futures may be telling you more about what the market might be doing
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