Basis Trade at Index Close’s (BTIC) multitude of use cases and subsequent versatility has led to widespread adoption of the functionality. This paper will highlight some of the key use cases and show why participants are embracing the product.

At the time of writing in January 2022, BTIC activity has been elevated due to increased market volatility which has helped reinforce the usefulness of BTIC in assisting clients manage their risk. For example, the ADV of BTIC on the BTIC on the E-mini S&P 500, E-mini Nasdaq-100, and E-mini Russell 2000 index futures are up 31%, 44% and 49% respectively vs. their 2021 ADV. 1

What is BTIC?

BTIC is a functionality available at CME which allows a participant throughout the trading session to trade a future by agreeing to a basis relative to that trading day’s official cash index close. Once the official cash index close is published, the traded BTIC price is added to it and this resultant level is the price at which the equity index futures will clear in the participant’s account.2

For instance, two participants agree to trade 750 contracts of E-mini S&P 500 March 2022 futures at a BTIC price of -9.10 vs. today’s closing index level. The S&P 500 official index closing price is published at $4,720.20, this means the participants traded 750 contracts of the E-mini S&P 500 March 2022 future at a price of $4,711.10 (4720.20 – 9.10).

Why is trading against the cash index close via an equity index future useful?

1)     Manage subscription/redemption flows – Most funds’ NAVs are calculated versus the index close, making it the optimal time to deploy or raise cash. BTIC allows clients to accurately target the cash index close in an efficient manner by trading an index future at the equivalent level to the cash index close. For many funds, using a future can be a capital efficient way to manage cash flow requirements by ensuring equity exposure is maintained and any cash drag on the portfolio is minimized.

2)     Operational efficiency – Trading a future rather than a basket of stock can be more operationally efficient. Trading futures via BTIC provides the ability to target the cash index close while enjoying the simplicity of trading a single instrument, an equity index future, rather than up to as many as 2000 index components (depending on the underlying index). Participants can also trade BTIC throughout the trading session, allowing them to trade the close well ahead of the busy closing bell, which in turn, frees up trading desk capacity.

3)     Options expiration risk – Cash index options which have PM expirations, typically expire against the official index closing price. Upon expiration of a cash index option, the delta associated with the position is reduced to zero. This is not always desirable, and the portfolio may concurrently require the delta to be re-established. BTIC can help to manage delta risk by replacing the delta exposure associated with the index option with that of an index future position. The inception of the futures position happens simultaneously to the option expiry (i.e., at the same official index closing price level) and thus there is no price dislocation when managing the delta.  

4)     Liquidity – The cash index close is calculated from the resultant prices of the component stocks’ end of day auction. This is by far the most liquid part of the cash trading day with almost 12% of daily volumes being traded in the closing auction.3 Many clients naturally want to take advantage of the liquidity on offer in this part of the day.

By trading an equity index future via BTIC, clients can trade larger than average orders at a price point that is typically competitive despite the larger order size. This is achievable thanks to two factors: the close is the most liquid part of the day and the index is easily replicated by BTIC liquidity providers who hedge via deploying a stock basket in the cash close or using other instruments tied to the cash close. Participants therefore use BTIC to deploy large size trades across a variety of CME Equity Index futures

5)     Ability to efficiently unwind hedged positions – When providing risk management to clients, many liquidity providers will hedge a given instrument with a futures contract or vice versa. For example, ETF market makers could choose to hedge a Nasdaq-100-based ETF with E-mini Nasdaq-100 futures. This hedged position will typically be initiated intraday and market makers will look to unwind these positions to flatten their books. An excellent time to do this is on the cash index close when trading both an ETF NAV and an equity index future via BTIC will unwind the positions using the same underlying cash index level, resulting in an equivalent price point for the unwind.

6)     Ability to switch exposure simultaneously – Whether making strategic or tactical allocations between equity index futures, clients often wish to ensure the switch happens simultaneously. Using BTIC on both index positions can ensure a seamless switch of positions on the cash close e.g., a switch from E-mini S&P 500 into E-mini Russell 2000 Index futures.

7)     Price certainty – BTIC provides certainty of the basis being applied to the official cash close, helping to minimize any tracking error. It is worth noting the tick size of BTIC is often finer than that of the outright futures ‒ allowing a more granular futures price to be agreed to and providing a high degree of accuracy vs. the benchmark close. In contrast, clients can choose to trade the outright futures around the index close, for example, deploying a VWAP or TWAP strategy over a few minutes into or around the market close. However, this strategy is likely to lead to tracking error as the exact index close is challenging to achieve.

8)     Breadth of index available – BTIC is available on nearly the entire CME Equity Index futures suite, as well as Commodity Index futures and Cryptocurrency futures. Currently, it can be used on 49 individual products and is actively utilized across the entire product suite.4

9)     Transparency – BTIC is available to trade both on the CME Globex order book and via block trades. The ability on any given day to not only have transparency about the basis of an equity index futures contract, but also to trade against that basis throughout the trading session is welcomed by clients and the market as a whole.

To find out more about BTIC please visit cmegroup.com/BTIC.

Sources

  1. As of 31 Jan 2022
  2. For more details on BTIC, please click here.
  3. Data from Blackrock study, “A global perspective on market on close activity”
  4. As of 31 Jan 2022

 

 

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