The Derivatives-on-Line Pages

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Future-spot convergence

As the delivery approaches, the futures price will eventually converge to the spot price of the underlying asset. Two alternative ways of doing so are presented in figure 2.1.

Figure 2.1: Forward--spot convergence
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If this was not the case, there would be clear arbitrage opportunities. For instance, if the futures were above the spot price, one could [and should] exploit the following arbitrage opportunity

  1. Short a futures

  2. Buy the asset

  3. Deliver

As arbitrageurs exploit this opportunity, the price of the futures will decline and the price of the underlying asset will rise. This pattern will continue until the futures and the spot price become equal. The futures price can approach the spot price either from below or above, something that will be explained later.

next up previous contents
Next: Hedging with futures Up: Hedging with Futures Previous: Open interest and volume   Contents
Kyriakos 2003-03-17