Question on Futures Premium

Discussion in 'Index Futures' started by Harry, Nov 14, 2003.

  1. Harry


    Good evening!

    I've read a short statement that fair value of a financial futures contract is "opposite" to fair value of a commodity futures contract - i.e. that one is higher than the cash price the other one is lower than the cash price - because there is cost of carry only in commidties and not in financials.

    Can someone explain this difference in an example or dows anyone know a good site to look at?

    Thanks a lot and have a nice weekend all,
  2. well, like in corn, you take the cash price and then add to it what it costs to store the grain until contract expiration. So Dec corn is stored in the ground but Mar corn is stored in the elevator.

    On the index, you take the cash price and minus out what the dividends are going to pay if the contract is held until expiration.

    So the futures discount gets smaller and smaller as we approach the end. And then they get wide all over again as the next contract becomes the nearby.

    So all you have to do is buy the cash and go long the futures when the spread is wide and you are guranteed to make money unless the market goes down.
  3. Harry


    So in a commodity future the price of the futures contract is always higher than the cash (until expiration where they should be the same)

    but in a financial futures contract the futures price is usually also higher than the cash = premium.

    ??? still confused, sorry ...
  4. no, sorry, I'll be more serious this time. The discount is the dividend plus what you could make in interest.

    So, the futures trade below the cash. On tv, they often misuse the term "fair value." There is a formula for computing it. Something like dividends plus t-bill rate minus cash divided by so many days...or something.

    If the futures are trading at or above the cash, it is because futures traders are betting the mkt will go up.

    At night in after hours trading they can trade all over the place while the cash just sits there contentedly closed for the night.
  5. Harry


    ok, thanks a lot for your patience.

    So can it be said that usually

    - in financial futures the future price will be lower than the cash
    - in commoditites the futures price will be higher than the cash


  6. right, and the closer the contract gets to expiration, the tighter the spread will be. And there are times in grains where the price is said to be inverted, or trading at a discount to cash, because supplies are tight, but the new crop looks to be more plentiful.
  7. Harry


    Thanks a lot!!!