But why does the amount of premium you pay for the futures always vary? right now you are paying 15 points for the front month, i seem to recall it being as low as 6, this is probably a dumb question but what causes the variance? I realize the S&P is an index based on the stocks cash price but shouldnt there always be some kind of arb price between cash and futures? Is it just because people are jacking the futures to try to make stocks go up and people dont believe it? Is there any set variable that will determine the difference between what the S&P cash and futures should be trading at?
A futures contract is priced based on a future date. The closer you get to the expiration date the closer the futures contract will be to the underlying index's actual current cash price.... or something like that.
Futures, same as options; don't have a fixed price. You can bid/ask any price you want, as long as there's someone willing to sell/buy at that price. So the premium reflects market expectations. Of course these expectations may be realistic, or not.
The primary factors are interest rates and time to expiration. The greater the time from today until contract expiration, the bigger the interest calculation [premium]. Each day, that gets smaller so the premium erodes.
So is that the sole determinant then? what about when the market is taking an absolute shit like the tech bubble burst did the futures ever invert where you would be actually paying a premium for cash because people assumed it would be lower at a future date? I am prety sure i remember switching months on the futures contract (I just pay attention for market direction) and seeing it trade at a premium as low as 6 points.
Sorry if this is dumb but could you please explain how interest rates factor in to all of this... btw thx everyone for the replies so far i understand the claculation for fair value but never had a true understanding of how ti works anyon on here have any better reading i could look into?
lol i understand and know the calculation but why does the calculation work, for some reason i always feel the need to know why something i am doing works, sorry if this is to complex and thx for all the help so far guys. I.E. why does the premium exist? I.E. why does the premum change?