Arbitraging futures contract

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Arbitraging futures contract발음듣기

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[Male voiceover] Let's say that the current market settlement price for a Futures Contract that specifies the delivery of a thousand pounds of apples on October 20th and just for the simplicity of the math in this example, let's assume that that is one year away and the current settlement price, the current market price on the future exchange for delivery on that date is $300.발음듣기

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Let's also assume that the current market price, if you were to buy or sell apples today not on October 20th, which is a year away but today, let's assume that the current market price is $200.발음듣기

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Let's also assume that if you were to take out a $200 loan that you would have to pay 10% interest.발음듣기

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If you were to borrow $200 today, you would essentially have to pay back $220 in a year.발음듣기

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Now, given all of the parameters that I've set up, is there a way to make risk-free profits?발음듣기

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Is there way to kind of arbitrage this situation?발음듣기

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And as you can imagine, there is and what we can do is, we can borrow $200, Let me list it all out.발음듣기

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We can borrow $200 and then use that $200 to buy 1,000 pounds of apples.발음듣기

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Then we buy 1,000 pounds of apples.발음듣기

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We keep them in our garage or some place like that and then we also sell or I guess we could say, we become the seller on this Futures Contract or we sell the Futures short, I guess is another way to think about it.발음듣기

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We also become the seller on the Futures Contract.발음듣기

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Essentially, we are agreeing to sell 1,000 pounds of apples on October 20th, a year from now for $300.발음듣기

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So I wanna show you is if we set it up this way, we are guaranteed to make money no matter what happens to the price of apples and that's why we're calling it an arbitrage because if you fast forward one year, so let's fast forward one year.발음듣기

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In one year, we definitely have 1,000 pounds of apples and just for the sake of simplicity, let's assume that apples don't get bad that I've somehow freeze-dried them or I don't know.발음듣기

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These are apples that never spoil.발음듣기

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(chuckles) Let's say a year from now, I have the thousand pounds of apples so I give the apples to settle the Futures Contract.발음듣기

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Give apples to settle the contract and then of course, I have my loan.발음듣기

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I have my loan of $200 but guess what?발음듣기

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When I settled the contract, when I settled the Futures Contract, I got $300.발음듣기

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So, I get 300 dollars and what do I owe?발음듣기

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Well, I owe $220 on my loan.발음듣기

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Let me subtract that out.발음듣기

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I owe $220 and so I made a guaranteed risk-free $80 of profit in one year and we're not thinking about how much money I might have had to set aside for margin but this essentially, just free money and if you think about it, if this settlement price is anything, if the settlement price is anything above the $220 then I'm going to make a risk-free profit.발음듣기

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One way to think about Futures pricing is even if you think there's going to be a cold snap and apples are going to disappear and there's going to be the shortage of apples and so you might say, "Hey, maybe the apple prices will go up." a year ago, there's always going to be a way to arbitrage it if the settlement price, if the growth in price is more than the cost of borrowing the same amount of money, the cost of borrowing $200.발음듣기

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In this situation, the cost of borrowing is $20.발음듣기

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The settlement price really shouldn't be, if we assume that there's no arbitrage opportunities, it really shouldn't be more than $220.발음듣기

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