Basic Question on Futures

Discussion in 'Index Futures' started by Steve06, Dec 31, 2009.

  1. Steve06


    Please tell me if I understand how futures work correctly:

    - Assume I wanted to speculate on the rise of the price of some underlying (say, a stock).
    - I take a long position in a futures contract on that stock. Today, the Futures price is 45$ and the stock price is 40$, so the basis amounts to 5$.
    - Assume the stock price does not move at all until expiration of the futures contract.

    1st question:
    - As a holder of a long position, I have lost, during the time to expiration and by daily settlement, small amounts summing up to the initial basis of 5$, right?

    2nd question:
    - And these 5$ have flown to the short party? Therefore, in the absence of volatility, the short position holder profits from the long position's loss of basis?

  2. That is correct according to my understanding.

    However, if the SSF is correctly priced, the net gain to the seller would equal the costs of holding the underlying for future delivery, so that the seller does not profit from the transaction. Ignoring dividends, the cost is primarily the time-value of money.

    That is, if he takes the sell side of the future and buys the stock at the same time, the cost of holding the stock to delivery would be exactly equal to the basis at the time of the transaction (if the future is fairly priced).