by Brandon Wendell, Online Trading Academy

While teaching a Professional Futures Trader course in Kansas City several weeks ago, I was demonstrating a technique that can predict the morning reversal of the S&P 500 Index and the related futures contracts due to arbitrage opportunities. This is a technique that I have used successfully for years when I traded stocks. It can also be used as an odds enhancer for intraday trading under certain circumstances.

In this article I will discuss the overall use of the tool for increasing your chances for successful trading. In next week's follow up article, I will detail the trading technique I use in order to take advantage of this arbitrage.

For those who may not know, there are a group of institutional traders, called program traders, who have their computers set to recognize mispricing between the S&P 500 Index and the S&P 500 Futures. When the mispricing occurs, they buy the undervalued security (or the stocks making up the index) and sell the overvalued one. This is known as an arbitrage opportunity.

Futures trade with high leverage in comparison to the stocks making up the indexes. Buying 100 shares of the SPY (the ETF that tracks the S&P 500 index) would cost nearly $19,700 at the time of this writing. Even with 2:1 margin, a trader would need $9850 to maintain the position. To trade one contract of the ES, (the S&P 500 eMini future), a trader only needs $5060. Or much less if it is an intraday trade.

Since a trader can put down smaller margin and trade futures in lieu of stocks, they could earn interest on the money they are not using by buying stock. Well, maybe when the US banks actually pay interest again. So the futures exchanges attach a fair value to the futures in order to make them priced similarly to the equivalent index. Additionally, a futures trader will not receive dividends as would the stock or ETF trader. That dividend value is subtracted from the interest to arrive at the fair value.