Unexpectedly Intriguing!
08 February 2018

There's an old joke that has two economists coming across a $20 bill on the sidewalk, which goes:

The young economist looks down and sees a $20 bill on the street and says, “Hey, look a twenty-dollar bill!”

Without even looking, his older and wiser colleague replies, “Nonsense. If there had been a twenty-dollar lying on the street, someone would have already picked it up by now.”

The joke is really about the efficient market hypothesis (EMH), which holds that:

... it is impossible to "beat the market" because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. According to the EMH, stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. As such, it should be impossible to outperform the overall market through expert stock selection or market timing, and the only way an investor can possibly obtain higher returns is by purchasing riskier investments.

We can see where that's often true, but is the market always that efficient?

U.S. $20 Bill - Source: https://www.uscurrency.gov/denominations/20

To quote the master: "In theory, there is no difference between theory and practice. In practice there is."

We think we have an example of that today, with an example that involves the S&P 500 quarterly dividend futures that are quoted by the CME Group. Because we track dividend futures closely, we couldn't help but notice that they really haven't moved since 15 December 2017, which happened to be the expiration date for 2017-Q4's dividend futures contracts. At that time, the following values for the amount of quarterly dividends per share expected to be paid out to S&P 500 shareholders by the end each of the indicated quarters were recorded:

  • 2018-Q1 (March 2018): $13.10
  • 2018-Q2 (June 2018): $12.70
  • 2018-Q3 (September 2018): $13.45
  • 2018-Q4 (December 2018): $13.75
  • 2019-Q1 (March 2019): $13.75

[Before we go any further, let's note that these values indicate the approximate amount of cash dividends per share that investors would reasonably expect to collect from their investment in the S&P 500 in the period from the end of the third Friday of the month preceding the indicated quarter through the end of the third Friday of the month ending the indicated quarter, which coincides with the expiration dates of the dividend futures contracts themselves. These values don't match the S&P 500's dividends per share figures that are reported by Standard and Poor, which cover the period of the calendar quarter itself, which runs from the first day of the month that begins the quarter through the last day of the month that ends the quarter.]

What's important about these values is that they haven't changed for a prolonged period of time, even though the expectations for future dividend payments have changed. The following chart shows how much those expectations have changed for the future quarters of 2018-Q2 and 2018-Q3 since 21 December 2017, which is based on the data that we've collected and calculated from the S&P 500's expected future quarterly dividends provided by IndexArb. [Note: IndexArb provides the total dividends expected to be paid out between now and the dividend futures contracts expiration date for the indicated month - to get these values for a given quarter, like 2018-Q2, you need to subtract the value provided for 2018-Q1 from the value provided for 2018-Q2, and so on...]

Future Quarterly Dividends per Share Expected for the S&P 500 in 2018-Q2 and 2018-Q3, 21 December 2017 through 8 February 2018

Keeping in mind that the CME Group's dividend futures represent a prediction of how much cash dividends per share will have been paid out by the time the indicated quarter's dividend futures contract expires, while IndexArb's dividend futures are simply an indication of where those expected dividends per share are right now, the current differences between these two sources of dividend futures suggests that there may be an investment opportunity related to the CME Group's tradable dividend futures contracts. An opportunity that shouldn't exist if this particular market were truly efficient, but which we believe exists because these dividend futures contracts are trading on very thin volumes.

Which would kind of make them like finding money on the sidewalk whenever they get to be too different from a more up-to-date picture of what investors are really expecting for the future.

If you're of an options-trading mind, the question is how would you take advantage of the opportunity presented by this situation for the S&P 500's dividend futures for both 2018-Q2 and 2018-Q3? Is this situation really the equivalent of finding money on the investing sidewalk? And if so, how would you pick it up and claim it as yours before somebody else might?

Regardless of the answers to these questions, it is suggestive evidence that all markets aren't always quite as efficient as many economists might like to think!

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