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As I understand it, you can mathematically determine a price for a stock
index futures contract at which it is not advantageous to arbitrage the
contract and the underlying stocks, i.e. program trading. That
"theoretical" price is called Fair Value. If the price is above Fair
Value, executing buy programs is profitable; if below, executing sell
programs is profitable. The Cox & Rubinstein book, or the Hull book, (or
any number of finance textbooks) has the equation spelled out.
And yes, the Premium is the difference between futures and cash, the
"actual" difference. So if the Premium strays far from Fair Value, it's
a good guess that someone's finger is about to press the trigger on a buy
program or sell program.
Ed
I understand that the Premium number that is reported is the difference
between the current futures contract and the cash value of the S&P 500
index. Recently CNBC has been talking abou the Fair Value number. Can
someone explain what this is and how calculated?
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