Suppose that there are no storage costs for crude oil and...

Suppose that there are no storage costs for crude oil and the interest rate for borrowing or lending is $4 \%$ per annum. How could you make money if the June and December futures contracts for a particular year trade at $$\$ 50$$ and $$\$ 56$$, respectively?

Labs

Want to see this concept in action?

NEW

Explore this concept interactively to see how it behaves as you change inputs.

View Labs

Key Concepts

Cost?of?Carry Model

This concept explains how the futures price of a commodity is related to the spot price by incorporating the costs of financing, storage, and any other costs or benefits associated with holding the physical commodity. In scenarios with no storage costs and a given interest rate, the primary factor affecting the futures price is the financing cost over the holding period, which should be reflected in the price differential between contracts of different maturities.

Calendar Spread Arbitrage

Calendar spread arbitrage involves exploiting mispricings between futures contracts with different delivery dates. By simultaneously taking long and short positions in futures contracts that should theoretically align based on cost-of-carry computations, an arbitrageur can secure a risk?free profit if the observed price difference deviates from the model’s predictions.

Risk?Free Arbitrage

Risk?free arbitrage refers to a trading strategy that aims to capture profit from discrepancies in pricing without incurring any market risk. In the context of futures markets, when the prices of contracts for different maturities do not properly reflect the cost-of-carry, a trader can design a strategy—such as buying the cheaper contract and selling the overpriced contract—to lock in a profit regardless of future market movements.

Please give Ace some feedback