Learn Futures Trading | Hedging Futures

One of the main reasons why futures contracts are incredibly popular is because of the fact that they are easy to buy and trade off as well as the market in futures is endowed by a number of natural buyers. However what will be seemingly the most attractive characteristic of the trade is what many financial expert call arbitrage, now this is a property of futures trading that ensures prices are fair in most of the situation and when prices do get to many different fronts, then that is the cue for investors to capitalize on the sales. Future prices in many situations if not all are linked precisely by the underlying commodity which is known as the spot price or the cash price. The underlying commodity may be anything probably oil, stocks or metals depending of the market.

However there is no definite spot price for any commodity and this is because futures contracts themselves are not definite in fact they come on a monthly delivery or quarterly intervals where they trade on the markets simultaneously. The expiry dates of any futures however will vary slightly to be noticed. The inter relationship that is there between the spot price and the future price is very close but not necessarily definite or exact. Futures prices of the delivery month more often resemble the actual price of the present month and in fact, they will be in one direction with the cash price in all accounts. This particular contract is known as the front month contracts and is actually one of the most traded.

As for contracts that are six to nine months away from delivery, futures prices on them will reflect certain external factor the least of those being investors opinions and other factors but even so, traders may as well feel that the factors which may be affecting trade at that present moment may not have that huge impacts compared to what they may have in some months coming. With these points well considered then it is logically okay to note that futures prices on the basis of these realities will hardly be the same as cash prices. However in any given day, there is a price for the contract that is a percentage of the cash price and this is the fair value price.

Fair value can be calculated mathematically and it involves the difference between buying the underlying commodity at that precise moment and tying up any capital while incurring storage expenses or just buying the future earning interest of freed up cash and delivering the product on the delivery date. The further way any product is from the delivery date the more it would cost because of storage expense and interest rates.