How to Spot Buy and Sell Programs

Dynamic Hedge blogs about correlation, relative value and quantitative analysis at


Program trading is a generic term used by people to describe different versions of the same thing.  I will occasionally post to Stocktwits when I see a buy or sell program cross my screen.  I’ve had some people email me questions so this so this post is to clarify what I’m watching when identifying active buy or sell programs.

Here’s the NYSE definition of program trading:

“Program trading” means either (A) index arbitrage or (B) any trading strategy involving the related purchase or sale of a “basket” or group of 15 or more stocks, provided, however, that the purchases or sales of stocks are part of a coordinated trading strategy, even if the purchases or sales are neither entered or executed contemporaneously, nor part of a trading strategy involving options or futures contracts on an index stock group, or options on any such futures contracts, or otherwise relating to a stock market index.

Program trading is large orders hitting the exchanges simultaneously.  It’s usually a large firm or fund putting a bunch of on trades at once.  That’s it — no big secret.

The definition used to be narrower and only included computer-driven trades exceeding $1 million.  The new broader definition is much better because it includes old guys managing a shit load of money who don’t care for computers and still phone floor brokers, and algorithmic traders who can potentially spread orders enough to avoid having to report it to the NYSE.

How do you know when there is program buying or selling?

I was trained as a spread trader so I’m naturally addicted to spreading everything under the sun.  One of the spreads I watch the closest is the premium, or the spread between the cash markets and the futures markets.

Cash market: The S&P 500 Index ($SPX) tracks the price of the component stocks in the S&P 500 Index.

Futures market: The S&P 500 Futures ($SP_F, $ES_F) are derivative contracts that derive their value from of the S&P 500 Index.

Premium: Equals the Cash Market minus the Futures Market.

Fair Value: The price of all the stocks in the S&P 500 multiplied by the risk-free rate minus the dividends payed until the expiration of the current futures contract.  Basically, the difference between what it costs you to own the stocks versus holding the futures until contract expiration.

Theoretically, the price for the futures contract should be the index price minus fair value.  But that only works in theory.  Realistically, futures prices can vary from the cash market because the S&P futures price is determined by supply and demand of the contract, and the cash market price is determined by the collective supply and demand of all the stocks in the S&P 500.  Why does this matter?  The S&P futures are among the most liquid futures contracts in the world.  If big money wants to move in the equity market, they use the $SP_F and $ES_F over all else.  Let me reiterate this point.  When big money moves, they move through the futures, not through individual stocks.  This means that while the futures market should be dictated by the cash market, the tail (futures) actually wags the dog (cash) more often than you’d think.

To see when the tail is wagging the dog you have to monitor the premium.  When the premium moves significantly away from fair value it means that there’s an elevated probability that big money is moving through the futures market.  When the premium is pushing significantly above fair value it means that buyers are aggressively bidding and using all the liquidity available to them at price points further away from fair value, and vice versa for selling.  You can interpret this a number of ways; under certain conditions you see buy programs begetting more buy programs.  The traders who have sold futures to a program buyer often have to buy stocks in the cash market to hedge.  Hedgers look for liquidity which can trigger stops; which changes supply and demand relationship.  This is what moves markets.  I’ve written about this before here.  In other cases, these spikes can be faded as a scalping play with the bet being that the move was a short term liquidity constraint.

Below is a chart of the S&P Index ($SPX) with the S&P Futures ($ES_F) overlaid and adjusted for fair value.

Notice which side the light blue bars appear relative to the black bars before and after the market selloff.  The black bars are the cash market and the light blue is the futures contract.  If you see light blue below the black, it means that the futures are most likely trading on the bid (sellers hitting bids equals net sellers).  If the light blue appears above the black, it means that futures are likely trading on the offer (buyers taking offers equals net buyers).  This is an example of what I call a futures driven market.  When the futures market is in control, the side of the market that the futures trade on dictates the direction of the market.  I will do another post on the relative differences between futures and cash driven markets at a later date.

Now here is a chart of the premium (same timeframe):

When you see a big spike either lower or higher that’s the total amount that the futures moved relative to the cash market.  Keep in mind that it takes a lot of money to move this spread because you’ve got high frequency and index arbitrage working against you with a profit motive to keep spread in tact.  When the premium moves that far and that fast there is a good change that a big order was filled and pushed the futures in that direction looking for liquidity.

What does this mean for trading?

When you’re looking at buy and sell spikes you are merely interpreting what you see.  When the premium gets stretched it indicates that the probability of program buying or selling actively occurring is higher than normal.  There are people who have attempted to quantify these moves in relation to fair value and assign a probability of program trading.  I’ve always found that this is more art than science.  Just because the premium moves doesn’t mean that there’s program trading occurring.  For example, if a big player drops a bid from the futures market the premium will drop lower.  News events can create volatility and cause the cash market and the futures market to be out of sync and dislocate the premium temporarily.  If a big component stock gets halted the premium may go out of whack for a while.  The premium could be getting pushed out of line for an agency trade where a fund is rebalancing.  Also, keep in mind that not all big players are created equal, and not all firms are market leaders.  In fact some firms are terrible and lose money regularly on their principle trading.  If you could tell which firm was doing what and if it was on an agency or principle basis, trading would be pretty easy and you wouldn’t have to worry about doing too much else for the rest of your life.  Unfortunately, that information is extremely difficult to come by.  The best we can do is interpret the footprint that program buying and selling leaves in the market.  That’s the secret.

A book could be written on most of the points I made in this post.  This is just an overview.  At least the next time I post a buy program or sell program hitting in real-time in my Stocktwits stream you’ll know what I’m talking about.

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