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S&P 500 Corner Part VI

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The Premium - Misunderstood Indicator

The Premium is is one of the most important equity market indicators and also a very misunderstood indicator. The reason for this confusion is that traders attempt to label a premium level as simply bullish or bearish. This indicator is more subtle and elegant than most and cannot be adequately interpreted in such rough terms.

What should be evaluated is the rate-of-change and the current reading in relation to an average of the premium.

Rate-of-Change

The S&P 500 futures premium swings widely -- the premium reading can climb very rapidly in a bullish market and in a bearish environment the premium can plunge dramatically. The futures market has many swings and false moves; the cash market which is calculated once a minute is a much more stable representation of value than futures. What happens is that the basis cash index will eventually decide the direction that the futures will take. Consequently, it is very practical to track the cash index.

It is critical to monitor premium closely -- if it makes a quick move, follow it closely. A rising premium and a sluggish cash market means that the futures are rallying. Frequently, cash will follow this move up. However, if after several minutes the cash market does not follow futures, then the futures will probably drop soon. The converse is also true.

Average of the Premium

It is of value to track the 10-day average of the premium. When the current premium value is above it’s 10-day average, there is a good possibility that the market will want to go higher. Conversely, when the current premium value is below its 10-day average, the likelihood of a down move increases.

Let’s say the premium is above its 10-day average and the time is correct -- near one of our Cycle Turnings. This may be a good time to buy. As you watch the market, the premium may start to rise even as the cash market falls. This is a strong indication of a bullish market. If time is at one of our Cycle Timing values, the stage is set. Either cash will rise and the futures will go very bullish or the premium will fall and both the futures and cash will tumble.

In the S&Ps it’s important to move quickly when the beginnings of a move are identified. The clues to the beginnings of moves occur before the move happens. It is critical at this point to act, otherwise the move will occur without you. It is imperative that you see the turn before it occurs and you must act on that knowledge, otherwise you will not profit.