chapter3 - Chapter 3 1 CHAPTER 3 Futures Prices In this...

Info iconThis preview shows pages 1–9. Sign up to view the full content.

View Full Document Right Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: Chapter 3 1 CHAPTER 3 Futures Prices In this chapter, we discuss how futures contracts are priced. This chapter is organized into the following sections: 1. Reading Futures Prices 2. The Basis and Spreads 3. Models of Futures Prices 4. Futures Prices and Expectations 5. Future Prices and Risk Aversion 6. Characteristics of Futures Prices Chapter 3 2 Reading Futures Prices TERMINOLOGY To understand how to read the Wall Street Journal futures price quotations, we need to first understand some terminology. Spot Price Spot price is the price of a good for immediate delivery. Nearby Contract Nearby contracts are the next contract to mature. Distant Contract Distant contracts are contracts that mature sometime after the nearby contracts. Chapter 3 3 Reading Futures Prices TERMINOLOGY Settlement Price Settlement price is the price that contracts are traded at the end of the trading day. Trading Session Settlement Price New term used to reflect round-the-clock trading. Open Interest Open interest is the number of futures contracts for which delivery is currently obligated. Chapter 3 4 Reading Futures Prices Insert figure 3.1 Here Chapter 3 5 How Trading Affects Open Interest Table 3.1 How Trading Affects Open Interest Time Action Open Interest t = 0 Trading opens for the popular widget contract. 0 t = 1 Trader A buys and Trader B sells 1 widget contract. 1 t = 2 Trader C buys and Trader D sells 3 widget contracts. 4 t = 3 Trader A sells and Trader D buys 1 widget contract. (Trader A has offset 1 contract and is out of the mar- ket. Trader D has offset 1 contract and is now short 2 contracts.) 3 t = 4 Trader C sells and Trader E buys 1 widget contract. 3 Trader Long Position Short Position Ending Posi- tions B C D E All Traders 2 1 3 1 2 3 The last column in Figure 3.1 shows the open interest or total number of contracts outstanding for each maturity month. Assume that today, Dec 1997, widget contract has just been listed for trading, but that the contract has not traded yet. Table 3.1 shows how trading affects open interest at different times ( t ). Chapter 3 6 Open Interest &Trading Volume Patterns Insert Figure 3.2 Here Insert Figure 3.3 Here Chapter 3 7 The Basis S = current spot price F 0,t = current futures price for delivery of the product at time t. The basis can be positive or negative at any given time. Normal Market Price for more distant futures are higher than for nearby futures. Inverted Market Distant futures prices are lower than the price for contracts nearer to expiration. t F S Basis ,- = The Basis The basis is the difference between the current cash price of a commodity and the futures price for the same commodity. Chapter 3 8 The Basis Table 3.2 Gold Prices and the Basis (July 11) Contract Prices The Basis CASH JUL (this year) AUG OCT DEC FEB (next year) APR JUN AUG OCT DEC 353.70 354.10 355.60 359.80 364.20 368.70 373.00 377.50 381.90 386.70 391.50 -.40 -1.90 -6.10 -10.50 -15.00 -19.30 -23.80 -28.20 -33.00 -37.80 Example: if the current price of gold in the cash market...
View Full Document

This note was uploaded on 02/28/2010 for the course MBA 87 taught by Professor Dpg during the Spring '10 term at Indian Institute Of Management, Kolkata.

Page1 / 66

chapter3 - Chapter 3 1 CHAPTER 3 Futures Prices In this...

This preview shows document pages 1 - 9. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online