Day Trading & Forex Forum

oriana

Can anyone tell me if futures expire approximately at the cash price. For example, will the March Wall St future expire at roughly the price the Dow is at that time? Also as the expiry date approaches will the futures price begin to converge with the cash price?

Thanks.

grantx

Oriana,

Yes, future will converge with cash. The reason for this being a future, on an index for example, represents the value of the current underlying index (the "cash" or "spot") at some point in the "future".

The future value is the "cost-of-carry"(?) of the cash index.

From the future's value, the underlying (theoretical) cash index value can be determined by discounting the future's value.

For example,
Cash index = 6840, interest rate = 4%, future expiry = 51 days.

Future value = Cash index x exp(interest rate) x (days/365)
= 6840 x exp(0.04 x 0.14) = 6878.

Cash value = Future value / exp(interest rate) x (days/365)
= 6878 / exp(0.04 x 0.14) = 6840.

Assuming no change in the value of the cash index, with 17 days to expiry the future value will equal 6852, ie less than the future value with 51 days to expiry. Another way to look at this is to think in terms of time value (days to expiry), ie the greater the time value, the greater the value of the future.

Assume the cash index at expiry has fallen to 6800. The future value is:

6800 x exp(0.04) x (0/365) = 6800, ie it has converged with the cash index.

Theoretically, if either cash and future diverge significantly from their theoretical values an arbitrage opportunity (risk-free trade) is available.

For example, if our future value is at 6903 (25 points above its theoretical value) then one would sell the over-priced future at 6903 and buy the constituents of the cash index for 6840. At expiry, assuming cash at 6800 we will have:

sell underlying constituents at 6800 = -40 (notice we have a loss here but it doesn’t matter)
buy future at 6800 = 103 ( we sold at 6903 and bought back at a lower price)
net = 103 – 40 = 63.

Someone said (one of the posters to T2W, Dashing Blade?) to the effect that all financial markets can be reduced to present, discounted and future (or forward) values. That’s pretty much it.

Grant.

prince-in-jail

In theory, with futures you have the obligation to accept or deliver the underlying instrument upon expiry. What is it exactly in an index future? What is it being converted to if I let my futures contracts expire?

A Dashing Blade

FTSE Index is (say) 5770 at expiry, the future is gonna expire at 5770 (give or take a point), if you're long a future then you will get 5770 x £10 credited o your account ('cos the FTSE trades at £10 per point). If your short then £57,700 will be debited from your account

For the DAX, it''l be closing value x EUR25 credited/debited etc

This (the cash element conversion) is true only for Index futures iirc, as it's impractical to deposit a basket of shares matching the FTSE. If you were holding a bond future, you'd recieve a load of bonds, oil futures you'd have to find a spare oil tanker etc.

Rhody Trader

Actually, it's not just the index instruments. There are a few examples, such as Eurodollars, which are cash delivery, so to speak.

__________________
John Forman
Author - The Essentials of Trading

A Dashing Blade

hence my "iirc" caveat RT!

Gotta feeling some agriculturals are cash settled these days as well.

Anyone remember the (possibly) apocraphyl story from the late 80's when Morgan Grenfell forgot to close out position in potato(?) futures for a client and had to take physical delivery?

grantx

DB,

Re your figures, haven't you left out the opening price in determining profit or loss? Eg, open at 5700, close at 5770, profit (loss) = 70 points x £10 = £700 (-£700) per contract.

Grant.

Rhody Trader

Hah, hah! I get it now. When I responded I had absolutely no clue what that was.

__________________
John Forman
Author - The Essentials of Trading