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How exactly would I go about investigating whether the S&P 500 stocks were currently over-valued compared with the price of the S&P 500 Index futures contract? Is it just a case of taking each S&P 500 stock price, ratio-ing it down using its S&P 500 constituent weighting and then summing them all up and comparing the number with the Index futures price?

Any small examples would be most welcome

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http://en.wikipedia.org/wiki/Futures_contract#Arbitrage_arguments

S(t) is the value of the index. Arb opportunity opens when you can buy (sell) the stocks (typically done with a representative basket of stocks) against the future for less (more), of course adding (subtracting) the cost of carry of the stocks.

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  • $\begingroup$ this has very little to nothing to do with the question at hand. The challenges arising from index arb are the necessity to execute multiple orders at very low latencies and to overcome the bid-offer spread in the underlyings, traded, the probability of getting filled when submitting orders around mid levels (its almost a given that index arb turns out to be a negative expected value proposition when being forced to be a complete market-taker), and the challenges to remain fully hedged when trading the arb. $\endgroup$
    – Matt Wolf
    Sep 17, 2013 at 7:01
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    $\begingroup$ the question at hand as I read it is figuring out "whether the S&P 500 stocks were currently over-valued compared with the price of the S&P 500 Index futures contract" he asked nothing of the execution risks and operational aspects behind performing the arbitrage... $\endgroup$ Sep 17, 2013 at 19:18
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    $\begingroup$ What I listed are key concerns that determine whether the arbitrage makes or loses money, they are far from being operational. Your answer links to the no arbitrage argument to price a future/forward. $\endgroup$
    – Matt Wolf
    Sep 18, 2013 at 3:03

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