Futures Pricing: Fair Value, Cost of Carry & Spot Parity
Master the mathematics of futures pricing, the Cost of Carry model, risk-free interest rates, dividend adjustments, fair value calculations, and cash-futures arbitrage.
Interactive Simulation & Visual Mechanics
Interact with the live mathematical model, order book, or candlestick structural diagram to understand the mechanics intuitively.
Interactive Concept Simulation
How the Mechanism Operates
The pricing of futures contracts is governed by the Cost of Carry model. Since buying a future requires only a margin deposit rather than 100% cash outlay, the trader can keep the remaining cash in a risk-free interest-bearing bank account.
Therefore, the futures contract must trade at a premium over the spot price equal to the risk-free financing interest rate for the duration until expiration. However, because future holders do not receive corporate dividends paid during the holding period, the expected dividend is subtracted from the carry cost.
On the exact minute of expiration, the Cost of Carry drops to zero, and the futures price converges perfectly with the spot index/stock price.
Dividend Season Futures Discount on IT Major
Infosys Spot traded at ₹1,800. March Futures traded at ₹1,782 (an apparent ₹18 discount).
Infosys had announced a ₹28 per share dividend with an ex-dividend date prior to the March futures expiry.
Fair value calculation: ₹1,800 + ₹10 (Interest) - ₹28 (Dividend) = ₹1,782. The futures were trading at exact fair value.
★ A futures discount is often not bearish; it mathematically discounts upcoming corporate cash dividends.
Non-Negotiable Risk Guidelines
Common Pitfalls & Remedies
Why it happens: Discount is often purely mathematical due to dividend deductions occurring before contract expiry.
Remedy: Calculate theoretical Cost of Carry Fair Value before drawing directional conclusions.
Frequently Asked Questions
What is Spot-Futures Convergence?
As days to expiration approach zero, the time value of money disappears, forcing the futures price to converge exactly to the underlying spot settlement price.
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