Futures Pricing

After learning about index futures, Rajesh had a logical question.

“Priya, I’ve noticed something. Futures price is not always exactly the same as the current market price. Why is that?”

Priya smiled.

“That’s a very important observation. Let’s understand how futures pricing works.”

Spot Price vs Futures Price

Priya began with the basics.

There are two important prices:

• Spot price → Current market price
• Futures price → Price of the futures contract

Rajesh said, “They move together, right?”

“Yes,” Priya replied. “But they are not always exactly the same.”

Why is the Futures Price Different?

Priya explained.

Futures price includes additional factors such as:

• Time remaining until expiry
• Cost of holding the asset
• Market expectations

Rajesh nodded.

“So the futures price is like a forward-looking price.”

“Exactly.”

Concept Behind Futures Pricing

Priya simplified the idea.

Think of the futures price as:

Spot Price + Cost of Carry

Where the cost of carry includes:

• Interest cost
• Storage cost (for commodities)
• Other holding costs

Role of Time in Pricing

Priya explained further.

Time plays a major role.

• Longer time to expiry → Higher difference possible
• Shorter time to expiry → Prices become closer

Rajesh said, “So near expiry, both prices almost match.”

“Correct,” Priya replied.

Convergence at Expiry

Priya highlighted an important rule.

At expiry:

• Futures price = Spot price

Rajesh asked, “Why does that happen?”

Priya explained.

Because:

• The contract is ending
• No future uncertainty remains

Practical Understanding

Priya added.

In real markets:

• Futures may trade slightly higher or lower than spot
• But direction remains the same

Rajesh said, “So if spot goes up, futures also go up.”

“Exactly.”

Introduction to Calendar Spreads

Rajesh asked, “What about trading between different expiry contracts?”

Priya smiled.

“That is called a calendar spread.”

What is a Calendar Spread?

Priya explained.

It involves:

• Buying one futures contract
• Selling another contract

Usually of different expiry dates.

Why Use Calendar Spreads?

Priya explained.

Traders use spreads to:

• Reduce risk
• Take advantage of price differences
• Trade time-based opportunities

Key Insight

Priya summarized.

“Futures pricing is not random. It follows a logical structure based on time and cost.”

Rajesh nodded.

“So understanding pricing helps me understand market behaviour better.”

“Exactly,” Priya replied.

Common Beginner Mistake

Priya warned.

Many beginners:

• Assume futures and spot must always be equal
• Ignore pricing differences

This leads to confusion.

Rajesh said, “Now I understand why the futures price is slightly different.”

Priya replied, “Yes. It reflects both current price and future expectations.”

Rajesh added, “And at expiry, everything becomes equal.”

“Exactly,” Priya said.

Key Takeaways

• Spot price is the current market price
• Futures price includes the cost of carry and the time factor
• Futures and spot move in the same direction
• Price difference reduces as expiry approaches
• At expiry, the futures price equals the spot price
• Calendar spreads involve trading between different expiries
• Pricing helps in understanding the market structure
• Futures pricing is logical, not random