Personal Finance & Money Asked on October 24, 2020
I am looking at the following website that shows the stock futures chain
https://www.cmegroup.com/trading/equity-index/us-index/sandp-500.html
The way I read this, the further out you go, the lower the price on the S&P 500. That is, most future traders believe that stock prices will be lower a year or two from now, than they are today. That does not seem right to me. What am I missing?
To a first approximation (ignoring interest and dividends), stock index futures are flat across expiration months at any given moment. This may be counterintuitive, but it does not conflict with the fact that stocks generally rise over time.
One way to see this is to note that the following are not equivalent:
The former is a riskless investment since the 2021 sale price is locked in up front; it's much like buying a 1-year CD. The latter is a risky investment because we don't know where the index will be in 2021. So the latter has an extra expected return to compensate for the risk.
If we look more closely at that "1-year CD", it should pay a competitive risk-free total return (which is nearly zero right now thanks to the Fed), but this return includes the dividends that will be earned on the stocks during that year. Thus, to give a nearly zero total return, the purchase and sale prices should produce a small loss balancing the dividends. That is why the 2021 future is priced slightly lower than the 2020 future.
Arbitrageurs actively trade these risk-free futures combinations against other risk-free investments and thereby keep their returns equal.
Correct answer by nanoman on October 24, 2020
Do most future traders really believe that stock prices will be lower in the next two years?
No. Futures traders probably believe that dividends will be lower in the next two years. This means that the listed prices are already higher than they would have been, had we not experienced a global heath crisis.
Answered by high-moral-high-intelligent on October 24, 2020
Get help from others!
Recent Questions
Recent Answers
© 2024 TransWikia.com. All rights reserved. Sites we Love: PCI Database, UKBizDB, Menu Kuliner, Sharing RPP