Going beyond spot-futures arbitrage, how do derivatives influence liquidity on the underlying market?
There are also less direct channels of influence from derivatives to enhanced liquidity on the underlying market. Day traders in individual stocks, who supply liquidity in these stocks, will be able to use index futures to offset their index exposure, and hence be able to function at lower levels of risk. For example, the NYSE specialist makes phone calls to Chicago almost every half an hour (while trading is going on) adjusting his index futures position as a function of his inventory. Every time a day trader is long security he will simultaneously be short index futures (to strip out his index exposure), and vice versa. Another aspect is rooted in security options markets. When security options markets exist, speculators on individual securities tend to go trade on the options market, and the focus of price discovery moves away from the cash market to the options market. More informed traders tend to cluster on the options market, and less informed orders tend to go to the cash marke
