An index (such as S&P 500) is made up of several components (in the case of the S&P 500, 500 large US stocks picked by S&P to represent the US market), and the value of the index is typically computed as a linear function of the component prices, where the details of the computation (such as the weights of the linear function) are determined in accordance with the index methodology.[1]
The idea of index arbitrage is to exploit discrepancies between the market price of a product that tracks the index (such as a Stock market index future or Exchange-traded fund) and the market prices of the underlying index components, which are typically stocks.[2][3] For example, an arbitrageur could take the current prices of traded stocks, calculate a synthetic index value using the relevant index methodology, and then apply an interest rate and dividend adjustment to calculate the "fair value" of the stock market index future.[4] If the stock market index future is trading above its "fair value", the arbitrageur can buy the component stocks and sell the index future. Likewise, if the stock market index futures is trading below its "fair value", the arbitrageur can short the component stocks and buy the index future. In both cases, then the arbitrageur would be exposed to Basis risk if the interest rate and dividend yield risks are left unhedged.
In a different example, the arbitrageur can take the current prices of traded stocks, calculate the "fair value" of an ETF (based on its holdings, which are chosen to track the index) and arbitrage between the market price of the ETF and the market prices of the stock holdings. In this scenario, the arbitrageur would use the ETF creation and redemption process to net-out the offsetting ETF and stock positions.[5]
index, arbitrage, this, article, needs, additional, citations, verification, please, help, improve, this, article, adding, citations, reliable, sources, unsourced, material, challenged, removed, find, sources, news, newspapers, books, scholar, jstor, january, . This article needs additional citations for verification Please help improve this article by adding citations to reliable sources Unsourced material may be challenged and removed Find sources Index arbitrage news newspapers books scholar JSTOR January 2022 Learn how and when to remove this template message Index arbitrage is a subset of statistical arbitrage focusing on index components An index such as S amp P 500 is made up of several components in the case of the S amp P 500 500 large US stocks picked by S amp P to represent the US market and the value of the index is typically computed as a linear function of the component prices where the details of the computation such as the weights of the linear function are determined in accordance with the index methodology 1 The idea of index arbitrage is to exploit discrepancies between the market price of a product that tracks the index such as a Stock market index future or Exchange traded fund and the market prices of the underlying index components which are typically stocks 2 3 For example an arbitrageur could take the current prices of traded stocks calculate a synthetic index value using the relevant index methodology and then apply an interest rate and dividend adjustment to calculate the fair value of the stock market index future 4 If the stock market index future is trading above its fair value the arbitrageur can buy the component stocks and sell the index future Likewise if the stock market index futures is trading below its fair value the arbitrageur can short the component stocks and buy the index future In both cases then the arbitrageur would be exposed to Basis risk if the interest rate and dividend yield risks are left unhedged In a different example the arbitrageur can take the current prices of traded stocks calculate the fair value of an ETF based on its holdings which are chosen to track the index and arbitrage between the market price of the ETF and the market prices of the stock holdings In this scenario the arbitrageur would use the ETF creation and redemption process to net out the offsetting ETF and stock positions 5 See also editAlgorithmic trading Complex event processing Dark pool Electronic trading Implementation shortfall Investment strategy Quantitative trading Quote stuffingReferences edit Methodology Matters S amp P Dow Jones Indices www spglobal com Retrieved 2022 01 06 Index arbitrage Index Arbitrage Explained Calculating Fair Value What Is The Creation Redemption Mechanism nbsp This finance related article is a stub You can help Wikipedia by expanding it vte Retrieved from https en wikipedia org w index php title Index arbitrage amp oldid 1177251261, wikipedia, wiki, book, books, library,
