Definition of 'Program Trading'
If, for example, the S&P500 futures market increases in value quickly, a company could buy a basket of stocks that proxies the S&P500 and at the same time sell the S&P500 future to the same value and when the stock prices catch up to the futures price (fair value) or the futures price drops back to the fair value they can reverse their position for a profit.
Program trades frequently deal with baskets of stocks that heavily weigh in an index and are executed on such massive scale their activity can cause highly volatile market situations. Regulatory bodies have put restrictions in place to ensure that this type of trading only takes place when liquidity in the markets can absorb it.
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