In general, What does it mean when they say “Futures converges to spot” at maturity? if you want specifics, i’m reading about basis risk in R40, schweser page 123. Lets say Spot now = $10, and the forward contract i enter long has a FP = $12. If the spot later in time is $15, what does that say about my forward contract? i thought the FP is ‘locked in’ at $12, as in i am obligated to buy it later at the fixed $12 price. am i mixing the $12 price with something else?
Yes, the future price changes value. Depending if expectations are for higher or lower spot prices in the future, then the Future contract will change. In your case if the spot of $15 leads the market to believe the future rate (same contract) will be even higher then there is a gain to the long. But your example does not really capture what the statement is getting at. A future is the expected spot rate at some time in the future (i.e. the market’s expectations). The value of a future changes over time with expectations as well. As time shortens between the spot price (i.e. a current interest rate or commodity price) and the future contract date, the two will converge because there become less and less uncertainty of the price at the future date. For instance the spot for a barrel of oil is say $78 and the 1 year future is say $100, in 11-1/2 months if the spot is $90 the future contract (which is only 2 weeks away) will be worth something much closer to $90, like $92 (for discussion sake). And as time continues and the length of time to the future contract maturing get closer and closer, the future value will get closer and closer to the current spot. Right? with one day left to the future contract and spot price at say $95, you can be assured that the future price will be nearly the same (differences due to counter party risk etc)
Char_Lee, It is that the futures price coverges to the spot price at the expiration of the future contract, right ? I mean it is not that the spot price converges to the futures price, am I right ? In your example, with one day left and if the future contract is $95.5, actually you are losing $4.5, right ? And if the spot price is $96 at the expiration date, the you are losing $4.0. Since the contracted price is $100. Am I right ?
AMC, the future price will converge to the spot price over time. In the example above you are correct, the LONG of the initial contract will have an approx loss of $4.50 if the final spot at future time T is $95.50.
Char-Lee Wrote: ------------------------------------------------------- > AMC, the future price will converge to the spot > price over time. In the example above you are > correct, the LONG of the initial contract will > have an approx loss of $4.50 if the final spot at > future time T is $95.50. TKVM for your response ! I meant that the futures price will converge to be exactly same the spot price on the expiration date. During the life of the futures contract, the futures price will converge to the spot price but fluctuates since spot price is fluctuating over time. If the spot price is $96 at the expiration date, then you are losing $4.0. Since the contracted price is $100. Am I right ?
There are 3 adjustments to Spot price to derive the futures price. 1. RFR 2. Convenience Yield 3. Storage Costs As futures expiry date comes closer, all 3 variables decay and tend to 0. At exactly the expiry date, since the adjustments are 0, Futures Price = Spot Price. PS: Futures prices is derived from the Spot price. NOT vice versa! Spot price usually depends on Demand/Supply besides other factors.
but the futures CONTRACT price ($100 in charlees example) that you agreed to is “set in stone” no? as in…the futures price may change, but the $100 you agreed to buy or sell is still the same yes?
Yep, that price is fixed. But the futures price for a 1 day term (if that exists) will virtually be the same as the spot price, while the 1 month future price will deviate further from the spot price, because interest, storage etc all have a longer time to influence it. At least that’s my understanding - correct me if I’m wrong.
I think there is a more simple way to explain this statement. If the maturity of the futures contract today is 6 month, the futures price will be different than the spot for many reasons including the risk free rate. So spot is 14 and futures prices is 14.4 for ex. Now assume that the futures expire in 10 minutes. Would you be willing to pay a futures price more than the spot? No because why would you pay more than the spot if you re certain to receive the spot. This is way the more you come close to the maturity, the more the futures price of any underlying will converge to the spot price of the underlying. It might also be conceptually easier to think about it like for options. If the expiry is in 5h, there is no more time value to the option and the value of the option will only reflect the difference between spot and strike. The value of the option will converge to its intrinsic value and finally be perfectly equal at expiry, like for futures ans spot prices. Hope it clear