Convergence Flashcards
What is convergence?
As the delivery month of a futures contract approaches the cash price and futures price converge.
What principle is hedging in the grain market based on?
The principle that cash market prices and futures market prices are highly correlated and move up and down together
Why does cash market prices and futures market prices go up and down together?
They are effected by the same economic and market factors
Why does convergence occur?
Because futures positions can be converted into cash at expiration
How do you reduce the risk of a loss in the cash market?
Take the opposite position in the futures market
You buy futures if you are…
Short in the cash market
You sell futures if you are…
Long in the cash market
Why do you take an opposite position?
It allows a loss in one market to be offset by a gain in another market.
Convergence assurés…
That Hedgers can expect a predictable relationship between cash and futures prices when they sell cash grain and offset their future hedges
What does managing basis mean
The predictability of the cash/futures price relationship and this is driven by convergence
What is arbitrage
Arbitrage is when market forces act to bring the two price lines back in line if they majorly diverge
Arbitrage : if the cash price is below the futures price….
You would buy grain in the cash market and simultaneously sell it in the futures market to take advantage of the price discrepancy. Grain warehouses that de liver on futures will act quickly to capitalize, which will bring the prices back in line.
Arbitrage: if cash prices are above the futures price its a profit oppurtunity to…
sell in the cash market and buy grain futures. An arbitrageur holds futures positions to delivery, and uses the loaded out grain to fulfill cabs marker obligation. This brings the lines together driving convergence
What does an arbitrageur do?
They hold futures positions to delivery, loads out and uses the loaded out grains to fulfill their cash market obligation. Keeping convergence line in line.
Why do we need arbitrageur
They preserve the relationship between the cash and the futures market and ensures that convergence takes place by the time the contract expires.
