Relationship between Spot & future Price

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Presentation transcript:

Relationship between Spot & future Price

Introduction Spot Price & Future Price

RECAP Delivery option First Notice Day Last Notice Day Last Trading Day Deliveries by Cash Settlement

Difference between spot & future price

Difference between Cash and Future markets CASH MARKET FUTURES MARKET The cash market refers to the buying and selling of physical commodities. The futures market deals with the buying or selling of future obligations to make or take delivery rather than the actual commodity. A cash market transaction occurs in the present A futures market transaction is an agreement for an exchange of the underlying asset in the future. The costs associated with holding the physical grain until the stated delivery date is referred to as the cost to carry. the cash price will be cheaper than the futures price due to the expenses related to carrying the commodity until delivery Futures price is relatively higher than cash price. FINANCIAL DERIVATIVES/SNSCT/MBA

Difference between Cash and Future markets FINANCIAL DERIVATIVES/SNSCT/MBA

RELATIONSHIP BETWEEN FUTRURE PRICE AND SPOT PRICE Convergence of futures price to spot price: As the delivery period for a futures contract is approached, the futures price converges to the spot price of the underlying asset. When the delivery period is reached, the futures price equals-or is very close- to the spot price. Suppose that the future price is above the spot price during the delivery period. Traders then have a clear arbitrage opportunity: Sell(Short) a futures contract Buy the asset Make delivery These steps are certain to lead to a profit equal to the amount by which the futures price exceeds the spot price. As trader exploit this opportunity, the futures price will fall.

RELATIONSHIP BETWEEN FUTRURE PRICE AND SPOT PRICE Convergence of futures price to spot price: The futures price is below the spot price during the delivery period. Companies interested in aquiring the asset will find it attractive to enter into a long futures contract and then wait for delivery to be made. The futures price will tend to rise. The result is that the futures price is very close to the spot price during the delivery period.

RELATIONSHIP BETWEEN FUTURE PRICE AND SPOT PRICE The futures price is above the spot price prior to the delivery period. The futures price is below the spot price prior to the delivery period.

BREAK…..

RELATIONSHIPPrice Convergence.mp4 BETWEEN FUTURE PRICE AND SPOT PRICE

Understanding Futures Markets Clearinghouses Guarantee that the traders will honor their obligations (solves issues of trust). Each trader has obligations only to the clearinghouse, not to other traders. Each exchange uses a futures clearinghouse. Clearinghouses may be part of a futures exchange (division), or a separate entity. Clearinghouses are “perfectly hedged” by maintaining no futures market position of their own. Chapter 1 Chapter 1

The Function of Clearinghouses in Futures Markets Obligations without a clearinghouse Buyer Seller Obligations with a clearinghouse Buyer Clearing- house Seller Chapter 1

Conclusion Difference between spot and future price Relationship between spot and future price Clearing house