Many people believe that futures pricing depends on predicting the market direction.
The reality is completely different:
Futures pricing is based on the principle of no arbitrage, not on forecasts.
1. Starting point: Spot Price
Any futures contract starts from the current price of the underlying asset.
The market does not 'imagine' a future price, but is based on the reality of today's price.
2. Cost of holding the asset (Cost of Carry)
Holding the asset until maturity involves costs and benefits, the most notable of which are:
•Cost of carry (risk-free interest rate)
•Storage and insurance costs (especially in commodities)
•The non-monetary yield of holding the asset (Convenience Yield)
These elements are the essence of the difference between the spot price and the futures price.
3. The principle of no arbitrage
If the futures price is higher or lower than its fair value, a risk-free profit opportunity arises.
At that point, market participants intervene in price arbitrage to bring the price back to its theoretical level.
4. Cost of carry model
The theoretical futures price is calculated according to the relationship:
F = S × e^(r + u − y)T
Where:
•S the spot price
•r interest rate
•u storage costs
•y holding yield
•T time until maturity
The equation reflects the economics of time, not market expectations.
5. Important special cases
•In stock index contracts, dividends replace storage costs.
•In currency contracts, the interest rate differential between the two currencies plays a crucial role.
•In bond contracts, the price must be adjusted for the effect of coupons and conversion factors.
6. Contango and backwardation
•Contango: the futures price is higher than the spot price
•Backwardation: the futures price is lower than the spot price
And these cases are not 'market mood', but a natural result of the cost of financing and the yield of holding.
7. Market price versus theoretical price
Futures prices may temporarily deviate due to:
•Liquidity weakness
•Financing constraints
•Difficulties in short selling
But in the medium to long term, price arbitrage brings prices back to their fair path.
Summary
Pricing futures contracts is not a tool for prediction.
Rather, a strict economic framework that ensures price consistency over time and prevents risk-free profits.
Understanding this difference is what distinguishes a trader from a professional.
And the speculator from the decision-maker.
