Price relationship between index futures, the Index, the ETFs, and the stocks in the Index and the Options Trading for all Four

[Edwin]

I'm trying to wrap my head around how pricing is affected between index futures, the ETF that is supposed to represent the Index, the Index, the stocks in the Index, and all of the options trading that occurs between all four.

 

For example, if we look at the ES futures, ES Futures options, SPX Options, shares of SPY, options for SPY, and the shares and options for all the stocks in the S&P 500, how is there a correlation in how price moves?  If there's a huge SPX put buyer, how is that going to directly affect the market and how pricing and trading works on everything associated with it?  Then if there's a huge call SPY call buyer, how does that balance out everything else that is going on?

 

How does a large option trade affect the price of the underlying?  If there's a huge buyer of calls or puts in a stock or ETF, how does that directly affect the underlying price of the stock or ETF?  I would think that pricing of the stock or ETF would be more directly affected by the big institutions that are trading shares of the stock or ETF, and not so much by the options trading.  I would think that the option shouldn't affect the price of the underlying that much until the option buyer exercises the option to buy or sell the shares of the underlying.

 

Hopefully my question makes sense, and someone has some input to make sense of what I'm asking.

 

Thanks

[Kim]

For SPX and SPY, I believe no order would impact the prices of the options. They are too big and too liquid. For other less liquid ETFs, there might be temporary change in the options prices, but not ETF prices.

[Edwin]

Thanks for the comment.  I guess my question is how does the price of an underlying change if there aren't many buyers or sellers of that particular underlying, but there's action in the surrounding index, futures, or options trading for the index and futures.  What happens if large institutions are selling the stocks in the index but there are large buyers of the futures and ETFs of the index that those stocks are in?  I guess another example would be stocks flowing out of individual stocks and into ETFs.

[Kim]

The price of the ETF is impacted only by prices of individual stocks that are part of the ETF. It will not be impacted by bug buyers or sellers. In your example, if the stocks that are sold by large institutions go down, the price of the ETF goes down proportionally, even if they buy that ETF. ETF prices unlike stocks are not impacted by demand/supply. 

 

Of course that doesn't mean that there will not be some temporary mispricing, due to very large orders. But most of the time, the price will return to reflect the "true" value of the ETF, which is close to NAV (Net Asset Value).

[Edwin]

Does large call buying directly affect the price of the underlying immediately?  Or is that typically an indirect relationship of traders seeing the call buying and then buying shares?

[Kim]

Again, the underlying price is usually not impacted.

[Edwin]

Thanks