VII: Futures 22: Arbitrage.

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VII: Futures 22: Hedges, Speculation, and Arbitrage.

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Presentation transcript:

VII: Futures 22: Arbitrage

Futures Hedge Speculate Arbitrage use futures to reduce risk on an existing position Speculate use futures to take on risk in the hope of making a profit Arbitrage Use the difference between spot and futures prices to generate risk-free profit

Arbitrage Shares of Discovery Café trade in the primary market (NYSE) and in the Champaign-Urbana Stock Exchange (CUSE). DVC $100 CUSE CUSE $1.50 brokerage $1.50 brokerage

Arbitrage Price range on the CUSE Arbitrage-free price range Buy CUSE & sell NYSE Buy NYSE & sell CUSE $100 NYSE

Arbitrage Price range on gold futures Arbitrage-free price range Buy futures & sell spot Buy spot & sell futures Low price Spot gold High price

Arbitrage Gold Futures Spot 1 year contract 1 c is 100 troy ounces Margin is $1,800 and $1000 per contract Spot Gold is trading at $370/ounce

Arbitrage Price range on gold futures Arbitrage-free price range Buy futures & sell spot Buy spot & sell futures $340 Spot gold $370 $400 © Oltheten & Waspi 2012

Arbitrage: Buy spot; sell futures Buy spot at $370/ounce Sell futures at $400/ ounce Profit: $30/ounce (minus a few costs of carry)

Arbitrage October 2011 Buy 100 ounces gold @$370/oz storage & insurance Sell 1 October 08 gold contract @ $400/oz Initial Margin Borrow at 5% for 12 months Initial Investment October 2012 Deliver gold @ $400 contracted price Margin returned Repay loan Principal interest Arbitrage Profit © Oltheten & Waspi 2012

Arbitrage October 2011 Buy 100 ounces gold @$370/oz storage & insurance Sell 1 October 07 gold contract @ $X/oz Initial Margin Borrow at 5% for 12 months Initial Investment October 2012 Deliver gold at contracted price $X Margin returned Repay loan Principal interest Arbitrage Profit © Oltheten & Waspi 2012

Arbitrage Arbitrage-free price range Buy futures & sell spot Buy spot & sell futures $340 Spot gold $370 © Oltheten & Waspi 2012

Arbitrage October 2011 Short Sell 100 ounces gold @$370/oz borrowing fee Buy 1 October 08 gold contract @ $340/oz Initial Margin Invest at 5% for 12 months Initial Investment October 2012 Take delivery of the gold @ $340 contracted price Margin returned Cash in investment Principal interest Arbitrage Profit © Oltheten & Waspi 2012

Arbitrage October 2011 Short Sell 100 ounces gold @$370/oz borrowing fee Buy 1 October 07 gold contract @ $X/oz Initial Margin Invest at 5% for 12 months Initial Investment October 2012 Take delivery of the gold @ $X contracted price Margin returned Cash in investment Principal interest Arbitrage Profit © Oltheten & Waspi 2012

Arbitrage Arbitrage-free price range Buy futures & sell spot Buy spot & sell futures Spot gold $370 © Oltheten & Waspi 2012

Futures III