Chapter: Futures Prices

Chapter: Futures Prices

1. Spot Price

   • Is the price of a good for an immediately delivery
     • Difference between the spot price and future price is called basis:
       • Convergence: Behavior of the basis that occurs when the spot price gets closer to the future price

2. Spread

   • Spread is the difference between two future prices
     • Intracommodity spread: Difference between two futures prices with different expiration day
       • Intercommodity spread: Difference between two future prices for two underlying goods

3. Normal Market: Prices for distant futures are higher

   • Inverted Market: Nearby future prices are higher

4. Model of futures prices

   • Cost of carry model in perfect markets
     • There is no transaction cost and no restrictions on free contracting between two parties
       • It exist arbitrage bounds
   • Cost of carry model in imperfect markets
     • Real markets imperfections have an impact in the relationship of prices
       • No arbitrage bounds, so arbitrage opportunity is allowed

5. Full Carry market concept

   • In a full carry market, prices match the relationship between equations, in other words, markets should be normal.
     • Five main factors why prices should move away from full carry:
       • Ease of short selling
         • Large supply
           • Nonseasonal production
             • Nonseasonal production
               • High storability
   • Above full carry: When the future price is above equation
   • Below full carry: When the future price is below equation

6. Speculation is needed for setting expected future spot prices and decisions making in arbitrage strategies

   • Limits to speculation factors:
     • Transaction Cost
       • Risk aversion
         • Theory of normal Backwardation:
           • The view that future prices tend to reserver the contract life due to the hedgers general desire to be short
         • Capital Asset Pricing Model
           • The model says that a specific risk can be eliminated through diversification, remaining a market risk that can not be avoided

7. Characteristics of future prices

   • Relationship between futures prices and forward prices for the same good
   • Forecasting ability of future prices
   • Distribution of future prices changes
   • Volatility of future prices and the effect of future prices volatility on the volatility of the cash market prices