What kind of liquidity is expected on index derivatives markets?
Impact cost on index derivatives markets is likely to be much smaller than that seen on the spot index. One thumb rule which is commonly used internationally is that the round {trip cost (i.e. twice the impact cost plus brokerage) of trades on index futures of around $0.5 million are around 0.01%, i.e. the index futures are around 20 times more liquid than the spot index (For example, in the US, the S&P 500 futures contract (on the CME) has spreads of around $100 on a minimum tradeable lot of around $400,000; i.e., the one{way impact cost is around 0.0125%). High liquidity is the essential appeal of index derivatives. If trading on the spot market were cheap, then many portfolio modifications would get done there itself. However, because transactions costs on the cash market are high, using derivatives is an appealing alternative.
