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Futures vs. holding the underlying

Posted: Thu Feb 13, 2014 2:26 am
by e9329
When holding the ZN (10Y Note) does the trader's total return include the coupon that one would receive if they were holding the gov't note outright or is it just a play on the price of the 10Y based on prevailing interest rates?

Similarly, if a trader was to purchase a $ amount of ES futures and the same $ amount of the SPY ETF, would the total return including dividends received from SPY equal the total 'capital gains' from the ES future during the period?


Excuse my newbness - I've put on the anti-flaming suit !

Posted: Thu Feb 13, 2014 4:29 pm
by ecritt
For markets that have sufficient arbitrage, you can expect to approximately match the "total return" of the underlying asset, using a futures (or forward) contract, IF, in addition to holding the futures contract, you invest in "risk free" debt instruments, an amount equivalent to the notional value of the futures (or forward) contract.

Example: To match the return of SPY (S&P 500 total return index ETF) using futures contracts, do the following. Determine the notional value of the desired investment in SPY. Use this amount to purchase 3-month Treasury Bills. Use a portion of these Treasury Bills to collateralize a futures position in the appropriate number of S&P 500 emini contracts. Repeat every three months as you are rolling the futures position.

Over time, this will approximate the total return of SPY. If you are wondering about dividends, the premium/discount ; "Fair Value" metric you see on the news in the mornings...bounces around from day to day to price all that stuff in...such that rolling futures contracts, collateralized by t-bills, is approximately the equivalent of holding SPY.

Posted: Thu Feb 13, 2014 4:40 pm
by e9329
ecritt wrote:For markets that have sufficient arbitrage, you can expect to approximately match the "total return" of the underlying asset, using a futures (or forward) contract, IF, in addition to holding the futures contract, you invest in "risk free" debt instruments, an amount equivalent to the notional value of the futures (or forward) contract.

Example: To match the return of SPY (S&P 500 total return index ETF) using futures contracts, do the following. Determine the notional value of the desired investment in SPY. Use this amount to purchase 3-month Treasury Bills. Use a portion of these Treasury Bills to collateralize a futures position in the appropriate number of S&P 500 emini contracts. Repeat every three months as you are rolling the futures position.

Over time, this will approximate the total return of SPY. If you are wondering about dividends, the premium/discount ; "Fair Value" metric you see on the news in the mornings...bounces around from day to day to price all that stuff in...such that rolling futures contracts, collateralized by t-bills, is approximately the equivalent of holding SPY.
Thank you for clarifying. I've read a lot of conflicting information on this.
https://institutions.interactivebrokers ... ntity=inst
"For this reason the "fair value" of the futures contract at any time is the value of the index plus interest less dividends."

It seems with short term bills paying so low or negative even after transaction costs, there isn't much risk-free return on the collateral these days.

Also, if one would receive nearly the total return, wouldn't non-US investors be able to bypass the Withholding Tax on the dividends by capturing the entire dividend using features?