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Finance and capital markets
Course: Finance and capital markets > Unit 9
Lesson 2: Forward and futures contracts- Forward contract introduction
- Futures introduction
- Motivation for the futures exchange
- Futures margin mechanics
- Verifying hedge with futures margin mechanics
- Futures and forward curves
- Contango from trader perspective
- Severe contango generally bearish
- Backwardation bullish or bearish
- Futures curves II
- Contango
- Backwardation
- Contango and backwardation review
- Upper bound on forward settlement price
- Lower bound on forward settlement price
- Arbitraging futures contract
- Arbitraging futures contracts II
- Futures fair value in the pre-market
- Interpreting futures fair value in the premarket
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Arbitraging futures contracts II
Arbitraging Futures Contracts II. Created by Sal Khan.
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Don't futures contract themselves have a price (not the delivery price)?
For example, when you buy a call option on a stock, you pay a price for the option. It appears there is nothing similar to that with futures contracts - is that correct?(5 votes)- Don't confuse options with futures and forwards. They are different because with options you have the right but not the obligation to deliver or take delivery. You do have to pay a premium for that optionality.(8 votes)
This seems to be completely dependent on finding someone nice enough to lend out their apples for a measly 1% return when they could easily sell the apples themselves and get the whole 5% on the $200. Why would something like this ever happen?(5 votes)- You (as the apple owner) may not have the time or resources to manage the arbitrage arrangement. As long as you're happy you got your apples back in a year when you need them, you get your 1% return with absolutely no effort expended on your part. In order to get the 5% (4% net) as the arbitrager you have to expend time and resources to organise the contract, organise a bond, ensure payment to the apple owner and organise the purchase and redelivery of the apples. to them It's fundamentally more work so you might be willing to accept a smaller cut for someone else to do it for you.(5 votes)
So Sal get's $210 because he puts that $200 from selling apples into bank account with 5% interest rate?(4 votes)
Yes. And he pays $2 to the person who sold the apples.(3 votes)
General question: what kinds of companies use futures contracts? I understand they mitigate volatility, but how does this affect consumers and those companies that don't participate in futures trading. Also, are there companies who have nothing to do with the commodity being traded that participate in this market? Finance seems like a reallly broad subject.(3 votes)
All kinds of companies utilize futures contracts to lock in prices for commodities, thus they can be sure what price they are going to pay for their supplies before they actually need them. This is good for the business and generally also good for consumers, because it helps keep the prices of the business's goods stable, which in turn is easier on the consumer. Futures are also used by financial companies and investors to trade securities. And yes, you can be part of the futures market without having anything to do with their commodities, futures themselves are also traded like securities on markets. :)(2 votes)
- How do I proceed with understanding futures trading charts such as http://futures.tradingcharts.com/marketquotes/RS.html.
What do the different columns mean and how are they calculated? What does Call Put mean?(3 votes) - Why is there interest on the apples?(2 votes)
Which interest are you talking about?
5% - After Selling the apples, you can invest the $200 cash to get 5%
1% - This is the price you pay for borrowing the apples - to compensate for the risk he assumes by giving you his apples for free.(3 votes)
- How do you know when to arbitrage by borrowing money, or arbitrage by borrowing the apples?(2 votes)
- what's the difference between a future and a call?(1 vote)
- In a call option, the buyer pays extra for the right to back out of the deal.(3 votes)
At0:53where does the interest come from? From what I understand you get $200 from borrowing and selling the apples and then pay $200 on a futures contract agreeing to buy the 1000 lb of apples in 1 year time. Doesn't that leave you with $0? Where does the $8 profit come from?(1 vote)
When you sold the apples, you got $200. You then loaned out that money for a year, giving you 5% interest on the $200. As a result, you get $210 back, because of the 5% interest. You then pay $200 to buy the apples back, leaving you $10. $2 are used to pay the one who loaned you the apples in the first place, resulting in a net profit of $8.(2 votes)
my guess that goes to all other Sal examples on risk free money is that there must have been times (when these mechanisms first appeared) when some people made out like bandits.
Now with computers and stuff the market must compensate almost in real time, annihilating opportunities of risk free money(1 vote)
Computers haven't completely replaced opportunities for arbitrage. Below is an example of a market currently going through heavy arbitrage.
Also, it's an entertaining way to understand how arbitraging and it's consequences work.
http://www.npr.org/blogs/money/2013/05/07/182010027/episode-456-marijuana-arbitrage(2 votes)
0:53Video transcript
Let's say that the settlement
price for delivering 1,000 pounds of
apples on October 20, which we're going to assume
is one year from now, let's assume that it's $200. Let's also assume that
the current market price for 1,000 pounds
of apples is also $200. So that future settlement
price is the same as the current market price. And we're also going to
assume, like the last example, that these apples that
we have never go bad. They're just things that
they never rot or anything. So they're as good in a
year as they are right now. Let's also assume, above
and beyond the assumptions of the last video, that
we can borrow and sell apples in the current market. That we can actually
short apples. So I go to someone who's got
1,000 pounds of apples who doesn't really see any need
for them over the next year, and I say, can I
borrow those apples? And what I do is I say,
I'll borrow those apples. I'll sell those apples
in the market today. And of the interest that
I get on those apples, I'm going to give you
1%, the person who actually owns the apples. And that person says,
oh, sure, why not? That way I actually get
some money on my apples that I had no intention
of using for a year. And then I, as the borrower
and seller, will get 4% net. I'll get 4% net on the apples. So given this reality, what
could I do, once again, to make a risk-free profit? Well, as you could imagine,
I can borrow and sell the apples for a year. So let me write this down. I'm going to borrow and
sell 1,000 pounds of apples. So if I just borrow
it today and sell it, today's market price is
$200 for 1,000 pounds. So I'm going to get $200. Now on top of that,
what I want to do is agree to be the buyer
on this futures contract. So let me write that down. Agree, you could say to go
long the futures contract, or agree to be buyer
on futures contract. So I'm agreeing,
a year from now, to buy 1,000 pounds
of apples for $200. So let's fast forward. Let's fast forward one year. So what's happened? So of the $200 I got
from shorting the apples I got 5% on that. But I had to give
1% to the person I borrowed the apples from. So I'm getting 4% net. 4% on $200 is $8. So now I now have $208 because
I got that 4% interest. It was $210. I gave $2.00 to the person
who lent me the apples. Now I can use $200 of
that to essentially uphold my part of
the futures contract, to buy the apples for $200,
for that agreed upon price. So $200 to buy apples. And I know I can do this
regardless of what the market price is because that was the
delivery price on the futures contract. So now I have $8 net. And those apples that
I've just bought, those 1,000 pounds
of apples, I can then use those apples to
return it to the person that I borrowed the apples from. So they got their apples back. And they got that 1% on the $200
over the course of the year. And I made a risk-free $8. So if you think
about it once again, this is setting a lower bound
on what the actual settlement price on the
futures contract is. I should not be able to
make this risk-free profit. If it's available,
then people will do it. And what it will do is
it will increase demand to be the buyer here. So this price should go up. And it would increase supply
on the selling side here. And so maybe this price
over here would go down.