I mentioned in my month-end report (click here) that the longer-dated CUS contracts were trading 1-2 points rich to fair value. That prompted a question of “what’s fair value”.
The following table show that the CUS (10-city) index is the weighted average of the ten component regional indices. I believe that the weightings were created in the same process that scaled all CS indices to 100 (as of 1/31/2000). Looking at the “Past CS Indices” columns one can see that the actual CUS number is the same as the weighted numbers. This becomes important on revisions as, if say historical revisions caused WDC to come in 1.0 point lower than expected, the impact on CUS would be -.078.
Looking at the forward contracts, one can see that the CUS weighted values and the actual CUS contracts don’t trade (or even have to trade) at the same values. While they will converge over time to maturity (assuming index weights don’t change) , there appear to be times when the CUS contract is bid above (or offered lower) than what I call the “fair value” of the weighted averages of the ten components. For example, the mid-point of the bids and offers on the futures of the weighted components of the CUS index was 164.6 (as of this writing), while the mid-point of the actual contract was 166.4 -a 1.8 point premium).
In practice,it might be expensive (in terms of posting margin) to be long (or short) the correct weighted amount of the component pieces of regional contracts of the CUS index, against the CUS contracts, and there’s no guarantee that convergence will occur well before expiration. I monitor this “fair-value” analysis, and have not seen any wide variations (beyond a few points) over the last year.
That said, I think that knowing whether the CUS contract is “fair-valued” might be a good trading tool as one looks for signs of sentiment and trading opportunities.