Stable Derivatives

Sometimes the most obvious things are the most prescient. Take for example, morning market reports, like this one:

Stock futures were pointing to more gains for the U.S. market Tuesday, a day after the Dow Jones Industrial Average closed at its highest level ever.

Futures on the S&P 500 were adding 2.10 points to 1558.70 and were 3.94 points above fair value. Nasdaq 100 futures were up 3.25 points at 2138.50 and were 4.96 points better than fair value.

Here in the United States, and the rest of the developed world, we take for granted that futures markets indicate an opening level, so we are more or less prepared for the first few hours in trading on the day.

This is why you tend to see more or less stable -- or at the very least, predictable -- movements in the early hours of trading. Not for punters on the Dow Jones or the FTSE are wild, sudden 5% swings in prices in the first hour of trading a popular phenomenon.

But this isn't the case the world over -- or even here in this country, either. The pink sheet Nasdaq market, or the Shanghai Composite, or the U.K.'s OFEX (Off-exchange) markets have no futures components to them. The result is that you tend to get wild price swings in each of these markets very early on in trading, which more or less sets a precedent for the volatility in the day's trading. Middle East stock exchanges are another great example, where a lack of futures markets has contributed to a distinctly colorful beta scenario: the market went up four times 2004, four-fold again in 2005, and halved last year and this year.

It's an often forgotten fact: although futures markets are incredibly risky, the net effect often reduces risk day-to-day.