How the FTSE/Dow Future Spread Bets are Priced

Q. How are the Daily FTSE and Wall Street prices calculated?


A: The most popular reported figure for index markets such as Wall Street (Dow Jones) or the FTSE is the cash level which is essentially computed from the weighted performance of all the constituent shares making up the index. The problem is that this figure is not traded directly and so the cash price most of the times will lag behind the futures market, in particular in volatile market conditions, with contracts sometimes trading at a considerable premium or discount to the underlying share index.

Since the futures market is regarded as a better price, spread betting providers often use it as a basis of their cash quotes, simply making a fair value adjustment for the cost of carry*. All major indices quoted by a spread betting firm have a Futures market related to them (i.e. the FTSE 100 has the LIFFE FTSE Futures market). This Future trades at a price which reflects the underlying market plus some adjustments. These adjustments are calculated from the theoretical value of dividends payable between today and the expiry of the Future AND the cost of carry for the index over the same period.

This Adjustment is called the 'Fair Value' [read more about Fair Value here]. A spread betting company will adjust the Daily Cash price of each index by it's own Fair Value number each day. Capital Spreads for instance links the 'Daily Cash' quote to the relevant future concerned and offsets the quote by the current Fair Value. Therefore the Cash Daily price is moved by the Futures price and not vice versa, this is because the cash price is a lagging market indicator which does not react in a timely manner to market moving news.

* This implies that is well possible that the cash level may be trading outside the quoted spread. Unfortunately, it is simple to check an index level with a spread betting provider's quote and wrongly conclude that the provider is marking up the price - but the reality is that the spread bet is based on the futures market.

Q. I still don't get it - how is a FTSE/Dow Future spread bet priced?

A: For all index market, spread betting providers use the Futures to price their markets + or - an amount called the 'Fair Value'.

The fair value is an amalgam of interest rate cost and dividends that are payable/receivable between now and the Futures expiry date. The fair value changes every day but the relationship between the Futures and the Cash tends to remain fairly stable throughout the day.

Sounds Complicated? Let's simplify things with an example:

We will assume annual futures rather than quarterly. We will assume the index stays constant at 100 (that would of course mean that the index was a bad investment, but that doesn't matter, we are trying to isolate the cost difference between this and a security, say, QL Freeway).

Assume dividends are 2% and interest rate is 4%. Ignoring the margin as that is a separate cost. Assume a spread of 0.4% (1 per mil per quarter, actually cheaper than that as only the first quarter is 1 per mil subsequent quarters are .5 per mil).

Then the financial spread bet futures price at the start of the contract is 101.8 - 102.2, that is spot price plus interest less dividends which is then finally adjusted for spread.

Buy the financial spread bet forward and deposit 100 in bank. In 1 year's time the price will be quoted at 99.8 - 100.2 that is the spot price adjusted for spread.

You will now have 104 in bank but will lose 2.4 (102.2 - 99.8) on settling the spread bet, a net profit of 1.6.

The alternative would be to say invest 100 in QL Freeway. A year later you will have earned dividends of 2 but you will have paid management charges of 1, a net gain of 1.

Thus FBS is .6 cheaper than QL Freeway i.e. a whole 60% cheaper. After factoring in the lost interest on the margin and the fact that the rolling annual spread is less than 4 per mil, this is still about 50% cheaper than QL and we know QL are simply the best.

Q. Why are the prices quoted by spread betting companies different from what I see on the live-feed screen?

A: Many years ago when I had a live feed, cash prices used to go up while the spread betting prices would go down and this puzzled me for a while. Since I also had a CBOT futures feed at the time I noted that the futures price and spread betting price would gap by 2 points. However, the difference between the cash price and the spread betting price was 14 points and this is when I realized that the actual prices I was buying were based on the future price.

Spread betting resembles trading in futures contracts and many spread-bet prices are based on stock or index futures rather than underlying cash securities or the quoted cash index level (confusingly, as they are called rolling cash bets). A spread betting firm will work out the prices for the Daily Cash Index by getting the futures price for say the DOW and then adding fair value to it as worked out by Bloomberg to the price.

Q. Why do spread betting providers use the futures and not the cash price to price the bets?

A: The reason spread betting providers use the futures and not the cash price to price the bets is that the Futures updates more frequently than the Cash Index, which relies on all shares trading/being quoted to move before changing. So spread betting providers have to use the Futures because they can trade in the Futures whereas you cannot actually trade the Cash index unless you buy/sell every single component (i.e. in the case of the FTSE 100 cash, you would need to buy/sell all 100 shares quoted to gain exposure).

Note also that the Rolling Daily quote will reflect the cash market, but there may be a slight difference in the price as the Futures update faster than the FTSE cash and the fair value may also change throughout the day.

Q. Why do the Futures update more frequently than the Cash Index?

A: The Futures updates more frequently than the cash as the Futures is a market that can be traded and will change with the bids and offers coming in from sellers and buyers. The Cash index does not need to update as quickly as the Futures as it is an indicator of the value of the top 100 companies in the UK.

The Futures is an actual market. The difference between the Cash and the Futures market is the interest and dividends payable before the end of the Futures contract. Then for spreadbetting you add the spread betting provider's spread to this to get the price.

Q. Why is there a different level in the underlying? Or do they use different assets?

I'm a little bit confused, when looking at the change in the FTSE 100 Daily, and at the change in the FTSE to finish up. I would say both contracts have the same underlying, but at this moment the FTSE 100 daily has a change of -55 and the FTSE to finish up has a change of -52. Why does a spread betters 'net change' differ from the underlying index?

A: The reason for the discrepancies is nothing more sinister than different 'close' times.

FTSE closes at 4.30pm at Price A.

IG Index closes a few minutes later at Price B.

For trading the FTSE it matters not a tot. If IG's rollover price (& that's all it is) closes higher than the actual makes no odds. For example you are long FTSE & will be rolling over a daily trade into the next day...

FTSE closes at 6500.

IG rollover price 6503.

So next day, let's say the real FTSE is +10 points, however IG's index FTSE price will show only +7 ...but you've already had the 3 points extra at rollover so it all evens out in the wash.

So don't get too hung up on the (seemingly) quoted price mismatches - a different rollover time/price doesn't affect the odds...on this bit IG are legit.

Q. Which spread bet companies support betting on far-out futures?

If I wanted to trade some commodities futures that are further out than those normally spread-bet, which spread betting company would be best? For instance, it's February now. If I wanted to trade in November Soybean or December Corn, which spread betting companies would (easily) allow this? Finspreads, for example, only quote March for both of those commodities, and they also quote May for Corn - nothing as far away as November or December.

A: I posed that question to 9 of the spreadbetting companies about a year and a half ago... The short answer is none of them do with one exception. It may be possible with IG Index. If you are going to be trading in point sizes equivalent to the underlying futures contracts, then call their trading desk and ask them for a quote. They told me that they would quote you a price then. For example, the CBOT agriculturals such as Corn or Soybeans are $50 per point. If you were to bet about £50 per point (approx 2 contracts) then you could trade deferred contracts.

 ...Continues here - Trading After-Hours/Out-of-Hours...

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