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Front Running S&P 500 Index Funds
James Christopher
posted Jul 16, 2015

I read "The Hugely Profitable, Wholly Legal Way to Game the Stock Market" by Yuji Nakamura of Bloomberg and decided to try my hand at a quick and dirty version of the strategy/phenomna presented in the article: front running index funds.

Recent trends in investing are showing a huge influx in the amount of money people are investing in index funds. Attracted by their passive management style, and consequently low fees, investors look to index funds as a source of consistent performance that neither beats nor comes up short relative to the market.

For example take the S&P 500.

The S&P 500 effect on the price of companies is nothing new and neither is front running. While "front running" is generally considered illegal, the strategy of buying stock in a company who is about to be added to the S&P 500 or any index is not. Naturally, index funds track the underlying assets of their indices, so when a new security is added there is a large influx of buy orders from funds trying to fulfill their mandate. This wave of orders raises the price of the security, and potentially yields profit for the savvy investor.

To delve into this further we need data on the index changes

We looked to our friends at EventVestor and they provided us a sample of data containing index addition and deletion events for the last 8 years (2007-present).

Here is the download link for the data I used. You will need to upload this data into the new Quantopian Research platform to fully interact with this notebook.

You can request your own sample data from EventVestor.

I'll explore this strategy and see how it changes over different time periods.

Disclaimer

The material on this website is provided for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation or endorsement for any security or strategy, nor does it constitute an offer to provide investment advisory services by Quantopian. In addition, the material offers no opinion with respect to the suitability of any security or specific investment. No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as none of Quantopian nor any of its affiliates is undertaking to provide investment advice, act as an adviser to any plan or entity subject to the Employee Retirement Income Security Act of 1974, as amended, individual retirement account or individual retirement annuity, or give advice in a fiduciary capacity with respect to the materials presented herein. If you are an individual retirement or other investor, contact your financial advisor or other fiduciary unrelated to Quantopian about whether any given investment idea, strategy, product or service described herein may be appropriate for your circumstances. All investments involve risk, including loss of principal. Quantopian makes no guarantees as to the accuracy or completeness of the views expressed in the website. The views are subject to change, and may have become unreliable for various reasons, including changes in market conditions or economic circumstances.

7 responses
James Miller
Jul 16, 2015

I love this.

Simon Thornington
Jul 16, 2015

I can't play with this at work, but what happens if you lag your trades by a day? I would have though that this was pretty efficient these days, and that the shares which are being added would jump on the announcement before you could trade with an algo like this...

James Christopher
Jul 16, 2015

Hey Simon,

Yeah I totally hear you, I have similar doubts still. I say still because I first started backtesting in daily mode and that extra delay made this strategy impossible to work. I think the biggest factor that plays into this strategy's efficacy is the quality and speed that you get your data, as you are right; the market hears rumors, and is waiting to pull the trigger. That being said you will still see a jump in price as all the funds are buying, and as I mentioned in the notebook that would be the optimal time to close the positions. I'd like to do an event study on this and really quantify the abnormal returns associated with both the announcement and the actual addition to the index, I figured it'd be good to get something out and start a discussion while its hot.

Simon Thornington
Jul 16, 2015

Yeah, I would expect the majority of this alpha to occur within the microseconds following the announcement, these days, unless you figure out yourself which candidates are likely to be added and then speculate on that basis.

James Christopher
Jul 16, 2015

On a similar note it would be cool to get volume and options data for a period of time preceding the announcement and see if there are indeed people running the speculation play, or perhaps have inside knowledge of who is going to be added.

@ James

I'm glad you like it!

William Price
Mar 27, 2016

I believe this used to be done with funds which track indices. Index trackers (Goldman Sachs was the example I was given) published the dates on which they would rebalance.

Alex Z
Nov 14, 2017

Does anybody implemented this strategy?

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The material on this website is provided for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation or endorsement for any security or strategy, nor does it constitute an offer to provide investment advisory services by Quantopian.

In addition, the material offers no opinion with respect to the suitability of any security or specific investment. No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as none of Quantopian nor any of its affiliates is undertaking to provide investment advice, act as an adviser to any plan or entity subject to the Employee Retirement Income Security Act of 1974, as amended, individual retirement account or individual retirement annuity, or give advice in a fiduciary capacity with respect to the materials presented herein. If you are an individual retirement or other investor, contact your financial advisor or other fiduciary unrelated to Quantopian about whether any given investment idea, strategy, product or service described herein may be appropriate for your circumstances. All investments involve risk, including loss of principal. Quantopian makes no guarantees as to the accuracy or completeness of the views expressed in the website. The views are subject to change, and may have become unreliable for various reasons, including changes in market conditions or economic circumstances.