Early unwindings and rollovers of stock index futures arbitrage programs: Analysis and implications for predicting expiration day effects
✍ Scribed by John J. Merrick Jr.
- Publisher
- John Wiley and Sons
- Year
- 1989
- Tongue
- English
- Weight
- 715 KB
- Volume
- 9
- Category
- Article
- ISSN
- 0270-7314
No coin nor oath required. For personal study only.
✦ Synopsis
I. INTRODUCTION
rogram traders take matched opposite positions in the cash stock and stock index P futures markets to earn profits from intermarket mispricings. The fair relation between the futures price and the cash stock index usually is analyzed through a simple forward pricing rule based on a holding period which ends on the futures contract's expiration date. Thus, the standard program trade plans to close out, "unwind", the cash stock side of its position with market orders placed at the exact moment that the index futures expires. This paper explores early unwindings and delayed unwindings (contract "rollovers") which are frequently preferred over hold-to-expiration trades given the patterns of mispricings and theoretical futures price changes observed since the start of index futures trading in 1982.
The returns to such strategic arbitrage trading programs are often much higher than those presumed by hold-to-expiration forward pricing rule trading. One important economic effect of early unwindings and rollovers is the creation of transactions cost discounts. Early unwindings and rollovers help explain why the arbitrage market can be active even though prices are within conventionally-measured transactions cost bounds.
Arbitrage program unwindings are thought to lie at the core of the expiration date stock market congestion effects documented by Stoll and Whaley (1986). This analysis suggests a complicated path-dependent rule for predicting the net positions of arbitragers prior to contract expiration days. Simulation results reported here provide some useful insights into the failure of Stoll and Whaley's attempt to predict the direction of cash market expiration day price effects.