Is It Normal for SPX to Be Cheaper Than Its Futures?
Is It Normal for SPX to Be Cheaper Than Its Futures?
By:Kai Zeng
Analyzing /ES premiums over SPX to understand /ES and SPX price differences
- /ES and SPX both represent the S&P 500, but they can trade at slightly different prices because of futures trading costs.
- The gap between these prices is influenced by the relationship between interest rates and dividend yields.
- This gap doesn’t necessarily present arbitrage opportunities because these factors are already accounted for in the pricing.
Investors around the world follow The S&P 500 more widely than any other index. Several instruments closely track it, including SPX (the index), SPY (an exchange traded fund, or ETF for short), and /ES (futures).
SPX and /ES have similar pricing, but there's a key difference: SPX is a cash index that can't be traded directly, whereas /ES represents the E-mini S&P 500 futures, which can be traded.
As of Nov. 19, /ES was trading at a premium to SPX, about 23 points higher. This prompts the question: Is /ES always priced higher than SPX, or is this an unusual occurrence? Why does this difference exist if both track the same set of underlying assets?
The difference reflects the cost of carry in futures, which includes dividends from the S&P 500 stocks and interest rate costs to finance the portfolio over the futures contract's duration.
Because /ES trades closely to the expected SPX forward value at settlement day, the formula for /ES is as follows:
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- r: risk-free rate
- q: dividend yield
- t: time until maturity
Whether /ES trades at a discount or premium to SPX depends on the relationship between the interest rate and dividend yield.
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If the interest rate is higher than the dividend yield, /ES will likely trade at a premium. Conversely, if the dividend yield exceeds the interest rate, /ES will trade at a discount.
Over the past 30 years, /ES has been priced higher than SPX during four significant periods. These periods align with when the Federal Reserve raised interest rates, highlighting the influence of interest rate changes on the /ES and SPX price gap.
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In June 2022, the Federal Reserve announced a surprising 75-basis point (bps) interest rate hike for the first time in nearly 30 years, which immediately widened the /ES to SPX spread.
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Here are the statistics showing how often /ES is higher than SPX, consistent with our earlier discussion. However, as the Fed has begun reducing interest rates and is expected to continue, we might see the spread narrow.
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Kai Zeng, director of the research team and head of Chinese content at tastylive, has 20 years of experience in markets and derivatives trading. He cohosts several live shows, including From Theory to Practice and Building Blocks. @kai_zeng1
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