Futures and Fair Values

In the futures market, there is what is called "fair value." Fair value is that price in the middle for a futures contract. There is a certain degree of equilibrium with the price that has been stated. This is because compounded interest is taken into account over a specific time period.

The compound interest is calculated, but so are the lost dividends because it's not physical stocks that are owned, but it is the actual contract that is owned. Basically, you are looking at the relationship between the futures and the cash involved. The formula that is used is quite complex because it uses the current short term interest rates and how much time is left until the contract expires to figure what the spread is between the futures and the money. This spread is what it "should be."

There is really no advantage to having the cash instead of the futures or the futures instead of the cash. To those who invest professionally, there is no economic difference when the spread is the fair value. It doesn't mater whether they own the stocks or the futures contracts. There are other elements that drive buying and selling.

Basics

You should understand the basics of futures and fair values. The S&P 500 contains futures that are traded on the Chicago Mercantile Exchange, or the CME. These futures are trading completely independent of the S&P. The contracts expire ever three months, so when referring to the next expiring contract that means that it is the next period. The next expiration month is called the "front month" because it is the next month in line, even if it is two months away.

Basically, futures contracts are "bets" on where the S&P will be in the future. The trades usually occur higher than the S&P, but when they are lower that is when the discounts occur. The cash that is being referred to is actually the S&P 500 itself and what you are looking at is the gap between the futures and the cash. This gap is also referred to as "the spread."

This spread is what you want to pay close attention to because it is what is going to help you determine whether or not you need to buy or sell, depending on what your position is. There are gains to be had as long as you are mindful of what is occurring with the spread.

When Fair Value Changes

It is possible for the spread to drop below fair value or it soars above fair value, which is when a decision needs to be made. The decision is going to be selling and buying.

It is not unusual for the spread to fluctuate throughout the day, so there is no need to become extremely alarmed. But what you'll find is that supply and demand, just like in the S&P 500, has quite the impact on how the spread moves throughout the day. The speeds in which they move change as well.

Your certified financial advisor can help you with the trading of futures, keeping you from having to worry about a lot of the terminology and the complexity that is involved in investing in futures. Furthermore, you know that your advisor is not going to place you in a position of intentional loss.

So when looking for a unique investment opportunity, futures is a place where you can find unique opportunities. Furthermore, you have access to a financial advisor who can help you in your decision making to ensure that you understand what is happening with futures and fair values with respect to your investment.

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