Our goal in this chapter is to discuss the basics of futures contracts and how their prices are quoted in the financial press. We will also look at how futures contracts are used and the relationship between current cash prices and futures prices.
Futures Contracts Basics Forward contract Agreement between a buyer and a seller, who both commit to a transaction at a future date at a price set by negotiation today. Futures contract Contract between a seller and a buyer specifying a commodity or financial instrument to be delivered and paid for at contract maturity. The specified price is called the futures price .
For a list of online futures brokers, visit the Commodities & Futures section of Investor Links at:
http://www. investorlinks .com
Cash Prices Cash price (or spot price) The price of a commodity or financial instrument for current delivery. Cash market (or spot market) The market in which commodities or financial instruments are traded for essentially immediate delivery.
Index arbitrage refers to the strategy of monitoring the futures price on a stock index and the level of the underlying index to exploit deviations from parity.
Index arbitrage is often implemented as a program trading strategy. Program trading accounts for about 15% of total trading volume on the NYSE, and about 20% of all program trading involves stock-index arbitrage.
Another phenomenon often associated with index arbitrage (and more generally, futures and options trading) is the triple witching hour effect.
S&P 500 futures contracts and options, and various stock options, all expire on the third Friday of four particular months per year. The closing out of all the positions held sometimes lead to unusual price behavior.