FUTURE PRICES
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Financial assets can be purchased and sold for future settlement in exchanges by entering into standardized future contracts, or in the OTC market by entering into Forward Contracts. Participants in the futures market include financial institutions, institutional players and sophisticated investors.
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Future prices are also used as a theoretical construct expressing an unfunded purchase or sale of an asset (the “underlying”) with no upfront exchange of the cash price and the asset. They are used as a key input in many derivative instruments valuation.
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Forwards are similar to futures but are not exchange traded and may have customized features (quantity, expiration dates, delivery method, etc.). They usually involve the use of margin with similar mechanics to futures.
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Futures and forwards are commonly traded instruments for a variety of asset classes, and share similarities to trading the underlying asset on margin.
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Prices for immediate settlement and for future settlement are closely tied together to the asset price, the income (interest dividends, etc.) and funding costs. Pricing of futures from spot markets also include a convenience yield, derived from the implicit benefit from holding an asset in storage and being able to deliver it upon request in exchange for a premium.
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Future and forward prices determine the difference between same strike option prices (“put call parity”). At a strike equal to the future price, puts and calls should have the same premium. At such price a leveraged party can create a forward settling position with no net premium paid or received by buying a call and selling a put, or by initiating a forward or future transaction.