What is the relationship between spot price and futures price with no arbitrage? (2024)

What is the relationship between spot price and futures price with no arbitrage?

The traditional no-arbitrage relation, initially developed for investment assets like stocks and bonds, states that the futures price F(t, T) of a contract written on the investment asset, observed at date t for a delivery at T, is the spot price St capitalized at the interest rate r between t and T: F(t, T) = Ster(T−t ...

What is the relationship between futures and spot prices?

Future Price. The main difference between spot prices and futures prices is that spot prices are for immediate buying and selling, while futures contracts delay payment and delivery to predetermined future dates. The spot price is usually below the futures price. The situation is known as contango.

What is the basis relationship between the nearby futures contract price and the spot cash price?

What is Basis. Basis is the difference between the futures price and your local cash price. For example, if the May futures contract is trading at $4.96 and the cash price is $4.63, the cash price is 33 cents under May ($4.63 - 4.96 = -33 cents). So the basis is -33 cents.

What is the relationship between forward prices and futures prices?

If futures prices are positively correlated with interest rates, then futures prices will exceed forward prices. If futures prices are negatively correlated with interest rates, then futures prices will be lower than forward prices.

What is no-arbitrage relationship?

In a financial market an arbitrage portfolio involves going short in some assets and long in others, with the portfolio having zero net cost but a positive expected return. No arbitrage means that no such portfolio can be constructed so asset prices are in equilibrium. From: no arbitrage in A Dictionary of Economics »

What is arbitrage between spot and futures?

In stock-futures arbitrage you buy in the cash market and sell the same stock in the same quantity in the futures market. Since the futures price will expire at the same price as the spot price on the F&O expiry day, the difference becomes the risk-free spread for the arbitrageur.

What is the difference between spot price and futures price?

Spot Price Vs Futures Price

Spot price is used to transact and pay immediately, whereas futures price is used when payment and delivery is made at a predetermined date of the future. In situation like contango, the spot price is less than futures price. In backwardation, it is just the opposite.

What basis is the difference between the futures price and the spot price?

The difference between the futures price and spot price of a currency pair is referred to as the basis. Basis can be either positive or negative. It will depend on the current relationship between the short-term interest rates of the base and terms currencies being considered.

Why do futures and spot prices converge?

Convergence happens because the market will not allow the same commodity to trade at two different prices at the same place at the same time.

What happens when spot price is greater than future price?

What Is Backwardation? Backwardation is when the current price, or spot price, of an underlying asset is higher than prices trading in the futures market.

When futures prices are higher than spot prices are said to be in?

When a market is in contango, the forward price of a futures contract is higher than the spot price. Conversely, when a market is in backwardation, the forward price of the futures contract is lower than the spot price.

What is the difference between buying spot and futures?

The main difference is the delivery date. Spot markets offer immediate or short-term delivery, while futures markets set delivery for a specified future date. In futures markets, prices result from buyer-seller agreements, whereas spot market prices reflect current supply and demand.

What is the relationship between spot market prices and forward market prices of a good or financial asset?

A spot rate is the current price at which a commodity, currency, or security can be purchased. A forward rate is the future price a currency trader agrees to or the yield on a bond on a future date.

What is the relationship between forward and futures?

While futures are highly liquid, forwards are typically low on liquidity. ETF Futures are typically more active in segments, like stocks, indices, currencies and commodities, while OTC Forwards usually sees larger participation in currency and commodity segments.

What is pricing by no-arbitrage?

Derivatives are priced using the no-arbitrage or arbitrage-free principle: the price of the derivative is set at the same level as the value of the replicating portfolio, so that no trader can make a risk-free profit by buying one and selling the other.

What is the difference between arbitrage and no-arbitrage?

The NO ARBITRAGE ASSUMPTION. Asset prices in a market do not allow arbitrage. In practice we take this to mean that, over time price movements due to arbitrageurs acting on arbitrage opportunities quickly close arbitrage oppor- tunities. Thus, on average, investors will see prices close to values allowing no arbitrage.

What is no arbitrage price forward?

The no-arbitrage approach is used for the pricing and valuation of forward commitments and is built on the key concept of the law of one price, which states that if two investments have the same future cash flows, regardless of what happens in the future, these two investments should have the same current price.

What does arbitrage mean in futures?

Arbitrage is the simultaneous purchase and sale of the same or similar asset in different markets in order to profit from tiny differences in the asset's listed price. It exploits short-lived variations in the price of identical or similar financial instruments in different markets or in different forms.

Does arbitrage affect price?

Arbitrage has the effect of causing prices in different markets to converge. As a result of arbitrage, the currency exchange rates, the price of commodities, and the price of securities in different markets tend to converge. The speed at which they do so is a measure of market efficiency.

How do you spot arbitrage?

The method for finding arbitrage opportunities entails looking for significantly differing odds on the same sporting event. If the odds differ greatly enough, there is a reasonable chance for arbitrage. A betting calculator will tell you how much opportunity is available. It helps to look at some real-world examples.

How do you calculate future price from spot price?

It is a mathematical representation of how futures price change if any of the market variable change.
  1. Futures Price = Spot price *(1+ rf – d) ...
  2. Futures Price = Spot price * [1+ rf*(x/365) – d] ...
  3. Mid-month calculation. ...
  4. Far-month calculation. ...
  5. Buying vs.

How do you explain futures pricing?

What does future price mean? A future price is measured by the moves in sync and the cost of the underlying asset. If the cost of underlying increases, the cost of futures will rise and if it decreases, the cost of future will fall.

Why use futures instead of spot?

High Leverage: Trading in futures is highly capital efficient. A trader is only required to put up a fraction of the total underlying to open a position in the futures market. Open Both Long and Short Positions: Unlike the spot market, traders in the futures market can earn profit regardless of price direction.

What happens when future price is less than spot price?

A backwardation is a scenario where the futures price of the asset is trading below its spot price. This is observed when the market expects the asset to decrease in value over time. For example, let the spot price for a stock be ₹2,000, and its futures price be ₹1,900.

Does backwardation happen when the futures prices are below the spot price?

Backwardation occurs when the difference between the forward price and the spot price is less than the cost of carry (when the forward price is less than the spot plus carry), or when there can be no delivery arbitrage because the asset is not currently available for purchase.

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