Spot–future parity


Spot–future parity is a parity condition whereby, if an asset can be purchased today and held until the exercise of a futures contract, the value of the future should equal the current spot price adjusted for the cost of money, dividends, "convenience yield" and any carrying costs. That is, if a person can purchase a good for price S and conclude a contract to sell it one month later at a price of F, the price difference should be no greater than the cost of using money less any expenses from holding the asset; if the difference is greater, the person has an opportunity to buy and sell the "spots" and "futures" for a risk-free profit, i.e. an arbitrage. Spot–future parity is an application of the law of one price; see also Rational pricing and #Futures.
The spot-future parity condition does not say that prices must be equal, but rather that when the condition is not met, it should be possible to sell one and purchase the other for a risk-free profit. In highly liquid and developed markets, actual prices on the spot and futures markets may effectively fulfill the condition. When the condition is consistently not met for a given asset, the implication is that some condition of the market prevents effective arbitration; possible reasons include high transaction costs, regulations and legal restrictions, low liquidity, or poor enforceability of legal contracts.
Spot–future parity can be used for virtually any asset where a future may be purchased, but is particularly common in currency markets, commodities, stock futures markets, and bond markets. It is also essential to price determination in swap markets.

Mathematical expression

In the complete form:
Where:
This may be simplified depending on the nature of the asset applicable; it is often seen in the form below, which applies for an asset with no dividends, storage or convenience costs. Alternatively, r can be seen as the net total cost of carrying. Note that the formulation assumes that transaction costs are insignificant.
Simplified form:

Pricing of existing futures contracts

Existing futures contracts can be priced using elements of the spot-futures parity equation, where is the settlement price of the existing contract, is the current spot price and is the value of the existing contract today:
which upon application of the spot-futures parity equation becomes:
Where is the forward price today.