It's a fairly safe bet that the price of a future will inch toward its spot price as the delivery month of a futures contract approaches, and it could even match the price. This is a very strong trend that occurs regardless of the contract's underlying asset.

The convergence is e🐈asily explained by a combination of arbitrage interest and the law of supply and demand.

Defining Futures Prices and Spot Prices

Investors in futures commit to buying or selling a🌳 quantity of something, generally a commodity like co꧙rn, at a set price for delivery at a future date. The origin of this market, and its practical use, is to help farmers and other producers of raw goods agree in advance with wholesale buyers on a reasonable price for a commodity.

Both sides benefit. Producers have a ready buyer and can proceed with their work, and get financing for their operations as needed. Wholesale buyers know what they'll be spending for supplies in the coming period, and can budget accordingly.

But that "reasonable" price may change repeatedly between the time that it is set and the time that the commodity is actually ready to deliver. A storm or a pest may reduce the supply of a crop and drive prices up. A recession may reduce consumer demand for precious metals and drive prices down.

Futures traders try to make a profitꦫ off of the differ𝓀ence between the futures price that has been set and the value of the commodity at the time it is actually ready for delivery.

Factors That Influence Convergence

Here are several items that impact the process and timing of when futures prices converg💜e with spot prices:

• Time to Maturity: As the expiration date of a futures contract approaches, the futures price tends to converge with the spot price. This is because the rest of the impacts below like interest rates, dividends, and storage costs becomes less significant as there is less time left for these elements to influence the price.
• Interest Rates: Higher interest rates increase the cost of carrying an asset, making futures prices higher relative to spot prices. Conversely, lower interest rates reduce the cost of holding assets, which helps futures prices converge more easily to spot prices as the expiration date approaches, since the impact of carrying costs decreases over time.
• Supply and Demand: The basic economic principle of 澳洲幸运5官方开奖结果体彩网:supply and demand also influences the convergence of futures prices to spot prices. For example, if demand for a commodity or asset rises, the spot price will increase, and futures prices will adjust accordingly.
• Market Expectations: Futures prices are influenced by market expectations about future supply, demand, and macroeconomic factors. These expectations can cause the futures price to diverge from the spot price initially. However, as the futures contract matures, expectations become clearer and the futures price adjusts to reflect the actual supply-demand conditions in the spot market.

How Arbitrage Affects Price

Suppose that the futures contract for corn is priced higher than the spot price as the contract's month of delivery approaches. When this happens, traders see an 澳洲幸运5官方开奖结果体彩网:arbitrage o🌳pportunity. That is, they will short futures contracts, buying the underlying asset, and then make the delivery.

The trader profits because the amount of money r♈eceived by shorting the contracts exceeds the amount spenꦛt buying the underlying asset to cover the position.

As for the pressure of supply and demand, the effect of ar𓂃bitrageurs shorting futures contracts causes a drop in futures prices because it creates an increase in the supply of contracts available for trade. Subsequently, buying the underlying asset causes an increase in the overall demand for the asset and the spot price of the underlying asset will increase as a result.

As arbitragers continue to do this, the futures price and the spot price will slowly converge until they are equal, or close to equal. The same sort of effect occurs when spot prices are higher than futures, except that arbitrageurs would in that case short sell the underlyinꦆg asset🔜 and long the futures contracts.

When Futures Prices Don't Converge With Spot Prices

If futures prices do n🌟ot converge with spot prices as the expiration date app♊roaches, it typically indicates an inefficiency or anomaly in the market.

In well-functioning markets, the convergence of futures prices to spot prices is a fundamental principle, driven by arbitrage opportunities that traders exploit to lock in risk-free profits. A failure to converge suggests that there is a disconnect between the futures and spot markets. One of the most common reasons for a lack of convergence is 澳洲幸运5官方开奖结果体彩网:insufficient market liquidity.

When there is low trading volume in the futures or spot market, it can lead to significant price discrepancies between the two. Without enough buyers and sellers to create equilibrium, the futures price may not accurately reflect th🔴e current spot price. This can result in futures prices diverging from spot prices, especially as the contract nears expiration.

Market manipulation is another 🔯potential cause of futures price failure to converge with the spot price. If large traders or entities intentionally influence futures prices by taking positions that disrupt the normal relationship between the futures and spot markets, it can cause prices to behave abnormally. Regulatory bodies closely monitor futures markets to detect and prevent such activities, but these practices can still happen.

The Bottom Line

Futures prices converge to spot prices as the contract nears expiration, driven by the reduction of factors like carrying costs, interest rates, and market expectations. This convergence ensures that at maturity, the futures price aligns with the underlying asset's actual market value, reflecting the spot price at that time. Without this convergence, there's an arbitrage opportunity as both prices should be equal when the time to expiration is 0.