Hello, I have a questions regarding futures and arbitrage. When the future price is undervalued, you buy the future and sells the spot. As people buy the future, the future price will go up and the arbitrage oppotunity will disapear. That’s in the book. Now what I dont understand is how future prices can go up? I though the price of a future is calculated as such: F= Spot (1+r) Since this is always how we calculate the price of a future, I dont see how “buying” future contracts will drive the price up. According to the formula, only the Spot price or the risk free rate can move the price of futures up. Not the demand for futures contract.
Supply and Demand influences the spot price. In any case, if the market expects demand for “oil” to increase in the future, people will buy oil **now (**not in the futures market) at a cheap price to sell it in the future at a higher price than anticipated by the arbitrage free formula. This will drive the spot price up, which in turn will drive the price of futures up. What’s the point with the model explained in the buying saying that buying futures contrart or selling a lot of them will drive their prices up or down to eliminate the arbitrage opportunity? I dont get it please. I think I am missing something.
Let’s say a bank misquotes a future price because of an error in the formula. Maybe they entered the wrong spot price or they made a typo in the risk free rate. A client sees that and starts buying futures like crazy from the bank. I dont see a reason why the price of this future will go up. That’s just a **** up from the bank and they cannot spot it until they double check their formula or realize that they have too many orders, which is unusual. The fact that people are buying the future doesnt not move the price up. There is no “supply and demand” effect. The bank just ****** up its formula on its excel file or whatever. So I still dont get the thing in the books saying that buying future contracts will drive their prices up? Future prices are just no arbitrage prices so this should not happen. They are not traded on the secondary market like bonds and everyone must use the same model to value them, unlike bonds where I can use different discount rates accroding to my expectations.