Lets say, I buy huge quantity of future contracts of a stock and as a result stock future price jumps +10% . Will actual stock price follow the future price? if yes, How does that work?
In: 1
A stock future is essentially a bet. You’re betting the stock will go up or down a certain amount at the time of expiry of your contract. Let’s say it’s at $300 right now and I think it’ll go to $350. I tell a guy hey I’ll pay you $20 now if you sell me your stock at $300 in 2 months time. 2 months goes by and the stock doesn’t go to $350. Say it goes to $310. I just lost $10. I paid money to have the luxury of taking that bet.
So no. Buying a large amount of futures, spiking the price, and expecting the actual stock price to move will not work as there is no actual real world value generated through that transaction to increase the net value of the actual stock price.
The entire futures market is just a bunch of people betting on what the stock price is going to be and a bunch of other people saying you know what, I’ll take you up on that bet. Now, obviously, they took the bet for a reason, so the prices between futures and the actual stock aren’t entirely uncorrelated. However. They are still just bets on future activity. The actual activity takes place with the stock itself which may or may not follow what the futures are predicting.
You might be wondering why they don’t track one to one. That’s primarily because when you buy a stock you’re buying something in this world. A part of a company. The majority of money moves through these actual assets. Money managers are investing in these real world assets that generate value in the real world to move the price of their stock as they see worthy. The futures market is speculation on what those moving the stock around think the stock is actually worth
If the futures price and the underlying price diverge, someone will come along and arbitrage it, and in doing so, will cause the prices to converge again.
For instance, let’s say the futures market is predicting that the price of a stock will be $100 in a month, and right now the stock is trading for $50. You could sell the futures contract (i.e. agree to sell the stock to someone for $100 in a month) and simultaneously buy the actual stock for $50. Then you don’t care what the price of the stock is in a month; either way you’re going to make $50, less whatever it costs you to hold on to the position for a month. As a side effect of you buying the stock, there will be upward pressure on the stock price, and as a side effect of you selling the futures contract, there will be downward pressure on the futures price. People will keep doing this until the prices are close enough together that the trade no longer makes sense.
The general concept of arbitrage is very important to the functioning of financial markets as a whole. Without arbitrage, ETFs and ADRs would not be possible either, as their pricing is kept in line with their underlying securities by the same mechanism.
Yes it will affect the underlying price.
The two assets are linked quite strongly. If someone issues a futures contract, they’d need to hedge the risk by buying the underlying stock. In this sense a futures contract is priced exactly as a function of the underlying price plus cost of interest/carry.
So if you manage to buy enough futures contracts to make a significant movement in the futures price, you will also have forced a significant amount of stock purchase.
Even in the case where all the contracts you purchased were not newly hedged, the difference in futures/underlying means there’s now an arbitrage opportunity. So other market participants will see this and either long the stock or short the futures.
Latest Answers