Spot and futures prices relationship tips

spot and futures prices relationship tips

In this paper we examine the relationship between spot and futures prices. relationship between futures and spot prices have to a large extent followed the. The aim of this paper is to analyze the dynamic relationship between spot and futures prices, and to establish if there is the possibility of a valid “period by. Here are a few tips for hedging financial risk using spot and futures markets. The relationship between the cash value of a commodity and its In these cases, the trade of futures contracts serves as a vital tool for risk.

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That is the futures price is equal to the cost of holding the underlying to the period of expiry. The cost of carry would normally include interest less dividends in the case of the SPI or storage costs in the case of a physical commodity like wool. As the futures get closer to expiry, the prices will naturally converge.

Why do futures prices converge on spot prices during the delivery month? -

This is because the futures price is in effect a price in the future the price at expiry that takes into account the cost of carry.

If this premium or discount gets out of equilibrium the forces of supply and demand will react. For example if a physical commodity is way above the futures price, this will bring in arbitragers, speculators and hedgers who will buy the "cheap" futures contract, rather than the physical commodity; this will create demand for the futures contract pushing the price up towards the physical.

spot and futures prices relationship tips

Arbitragers may also come into play and actively buy the futures and sell the physical hence locking in a profit. If the market was the other way around where futures were at a premium far in excess of the physical the market would be selling the futures and buying the physical.

spot and futures prices relationship tips

This activity can sometimes be seen particularly in the SPI where the premium gets driven far in excess of fair value in itself a subjective calculation ,and then a few days later the arbitrage is unwound bringing the market back to equilibrium. So come to expiry time, with the cost of carry approaching zero the futures price will naturally converge to the physical price. This is especially evident in a deliverable contract where the participants must be able to buy in one market and sell in another.

Now, when we move to 1, the way I've labeled this axis, it says one month from now.

Futures and forward curves (video) | Khan Academy

This is not saying that the market price is going to go up one month from now. This is saying that today, if you were to go into the Futures market and say, "I want to sell," or, "I want to buy apples "one month from now. I'm gonna repeat what I just said.

  • Futures and forward curves

This is not saying that a month from now that the market price that the Spot Price is going to move up. Only this time 0 is the Spot Price.

spot and futures prices relationship tips

What this is saying is right now, the market is saying, "If you want to enter "into a Futures contract for delivery a month from now, "that delivery price will be 12 cents.

This one that we're highlighting right now, I've drawn two Futures Curves.

Futures Basis

I've drawn an upwards sloping orange one and I've also drawn a downward sloping blue one and I'll focus on that one in the next video but this upward sloping is kind of a normal curve and it's actually called that.

It's a Normal Curve because this is what you actually expect for most types of commodities. You could imagine why.