From the course: Derivatives Fundamentals

Unlock this course with a free trial

Join today to access over 25,200 courses taught by industry experts.

How futures prices are calculated

How futures prices are calculated

From the course: Derivatives Fundamentals

Start my 1-month free trial Buy for my team

How futures prices are calculated

“

- [Instructor] How are futures prices calculated? Well, let's work through an example. Imagine that you plan to buy a thousand barrels of oil in one year's time. That's when you actually need the oil. There are two strategies you could consider. Strategy 1 would involve you buying the oil now even though you don't need it now, and then storing it for a year until you need it. The cost associated with the strategy would be, first of all, we need to borrow money to buy the thousand barrels of oil, and we also will need to pay interest on that loan, and we'll also have to pay storage cost. So we can think of the cost of this strategy as the spot price, the price of a barrel of oil plus two carry costs. We have the cost of interest on the loan, plus we have storage or warehousing cost. For some futures, there can be an underlying asset that provides a carry return. So the formula you see here is the full formula, the spot price, plus the carry costs minus the carry return. An example of a…

Contents