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# Futures curves II

Futures Curves II. Created by Sal Khan.

## Want to join the conversation?

• The price of the contract when it comes time to deliver converges to the spot price but how does that make sense when a futures contract states the price at which the commodity is to be transacted at?

The value of the contract taken out today for delivery in 4 months is about 34 dollars an ounce. But in four months the value of that contract is closer to the spot price but the parties involved still agreed to buy or sell the commodity at 34 dollars an ounce, is that not what the price is? Or does this go back to mark-to-market and the margins somehow?
• Technically each day every single futures contract is closed and a new one is opened.

For example, lets say you buy a futures contract for delivery in 4 months that is currently trading at 34 dollars. At the end of the first trading day the contract closes at 35 dollars. That dollar is added to your margin account by the clearinghouse, the contract is closed and a new one is opened up for trading the next day at 35 dollars. This process repeats itself all the way up until delivery. So, the actual delivery will happen at the spot price, but your account will have gains or losses equal to the difference between the spot price and your original purchase price. So, in the end it works out to being the same.
• For some reason I'm not quite getting this and how the two graphs relate. Is the graph on the right showing the reality of what happened and the left showing what you paid at that time (for instance, the guy that paid the 4 month future price at \$34 actually paid more than he should have?)
• The green dot on the left graph represents a 4-month future contract for silver delivery @ \$34. The right graph shows the movement of the spot price of silver as time goes on (the real price so to say). What Sal is saying is that the future contract itself will be out of the money (nobody would want to buy it) as it approaches the 4-month maturity limit cuz why would anyone buy a future contract that is expiring in let's say a week with a delivery price of \$34 when silver is trading now @ roughly \$32? So the contract itself will converge with the spot price meaning that the value of the contract will decrease by \$2 so that even if the delivery price is what it states (\$34) the buyer would still only pay \$32.

Hope that clears it up :)
• Are futures and options similar in that you're essentially paying a premium for the time values?
• Yes, but the option comes with a premium because it limits the potential loss an investor can make to the amount of the premium paid. If an investor buys a call option and the price of the underlying reduces, the call option will expire worthless; however the investor will have lost only the premium paid. In a futures contract, in a similar situation, the investor will lose money equal to the difference between the agreed price in the futures contract initially, and the current market price.
• i still don't get the idea in this video. especially about convergence?
• The futures price for a commodity and its current spot price will differ today. The difference between the futures price and the spot price will reduce as time progresses because the uncertainty and the risk associated with the time period goes down as time elapses.
Put it like this: if the futures price to buy gold were \$1400/oz for a week from today, and the spot price were \$1450/oz, would you go for the futures contract? Probably not, because you'd think: how much could the price fluctuate in a week's time? But if the same price was quoted for a year from today, you'd be dealing with a much higher degree of uncertainty, a much higher level of risk, and thus, the price of the futures contract would also be further away from the spot price, probably something like \$1300/oz.
(1 vote)
• Just to clarify, in the beginning of the video, you mentioned spot price is the current price now. So essentially is the spot price essentially the market price of a commodity? just in a different nomenclature?
(1 vote)
• Futures prices are also market prices. Spot prices are CURRENT market prices.
• How the prices of futures are determined?
(1 vote)
• There is a market for them. It's just like buying a house. The seller offers it at their price, but you can haggle and strike an agreement on a price that works best for both of you. :)
• Futures contracts are kind of like options
(1 vote)
• I read all questions still not get the video. The first graph green dot meaning we agree to pay 34 dollar to delivery in 4 months. The second graph is 'how much future contract worth' ? for green dot, how do you know after 4 months it will go to 32 dollars month 0 spot price? what it it go to 30 dollars?
(1 vote)
• I thought that the "futures" price is the exercise price that is fixed. When you say the 'futures' price is converging to the spot over time, are you referring to the price that the contract is traded on in the secondary market? What am I not understanding?
(1 vote)
• Since futures usually get closer down to the commodity price, that price would have to go up significantly in order to make a profit on the future, right? So investing in the commodity would have a higher return. Is this difference in return due to cantango?
(1 vote)
• If you invest in the commodity, you will end up paying less than if you used a future. However, if you invest in the commodity, you will also have to pay for storage, and since the purchase is delayed, you can invest your money in other things in the meantime.
(1 vote)