Arbitraging futures contract | Finance & Capital Markets | Khan Academy | Summary and Q&A

TL;DR

By taking advantage of price discrepancies between current market prices and futures contracts, it is possible to make risk-free profits through arbitrage.

Key Insights

• 🥶 Futures contracts can provide opportunities for risk-free profits through arbitrage.
• 🤩 Taking advantage of price discrepancies between current market prices and futures contracts is the key to successful arbitrage.
• 😘 Borrowing money at a lower interest rate and buying a commodity at a lower market price are strategies to maximize arbitrage profits.
• 🇨🇷 Settlement prices should not exceed the cost of borrowing for efficient arbitrage opportunities.
• 🥶 Commodities with higher settlement prices than borrowing costs offer the best potential for risk-free profits.
• ✋ Arbitrage opportunities exist as long as the settlement price is higher than the cost of borrowing.
• ✳️ Margin requirements and market fluctuations may introduce some risks into arbitrage strategies.

Transcript

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 de... Read More

Questions & Answers

Q: How can one make risk-free profits with futures contracts?

By borrowing money at a lower interest rate, buying a commodity at a lower market price, and selling a futures contract at a higher settlement price, it is possible to make a guaranteed profit.

Q: What are the key parameters for arbitrage opportunities in futures contracts?

The key parameters are the current market price, the settlement price, the cost of borrowing, and the difference between the market price and the settlement price.

Q: Can arbitrage be done with any commodity or only specific ones?

Arbitrage opportunities exist for commodities where the settlement price is higher than the cost of borrowing. It depends on the price difference and the interest rates.

Q: Are there any risks involved in arbitraging futures contracts?

In theory, if all parameters are correct, there should be no risks involved. However, there could be potential risks associated with margin requirements and unforeseen market fluctuations.

Summary & Key Takeaways

• The current market settlement price for a Futures Contract for apples to be delivered in one year is $300, while the current market price today is $200.

• By borrowing $200, buying 1,000 pounds of apples, and simultaneously selling the futures contract, it is possible to make a guaranteed risk-free profit of $80 in one year.

• As long as the settlement price is higher than the cost of borrowing, there is always an opportunity for arbitrage.