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I don't fully understand Futures & Forward pricing. I know that there is a delivery price and the actual future price. And that at the time of issuing, the future price is identical to the delivery price.

From my textbook, I have that the future price F_0 is given by

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where S_0 is the spot price. So, at issuance, the delivery price would be F_0.

So, should I buy the contract, I would receive the underlying at expiry T having paid F_0.

Now let's suppose that time passes, and the future price has increased. I now decide to buy the contract at time t1 and we have that F_0 is different from F_t1.

When the contract expires, I simply receive the asset from the contract which I have payed F_t1. So, where does the delivery price come into play?

If it doesn't, wouldn't the correct definition of a future contract be 'a legal agreement to buy or sell a particular commodity asset, or security at a specified time in the future' instead of 'a legal agreement to buy or sell a particular commodity asset, or security at a predetermined price at a specified time in the future'

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That formula is not always true. It is true for things like stocks that have no cost to store, but for physical commodities the futures price can be different than just the future value of the current price.

As an example, if I am a bread maker and know that I need to buy wheat in 3 months, I can either buy it now and store it, or "buy" a futures contract to lock in the price I want to pay in 3 months. That futures price must be cheaper than the current price plus 3 months of storage costs to make it worth buying; otherwise I would just buy it now and store it (ignoring spoilage and other factors).

For the rest of the question, note that you don't "buy" or "sell" a futures contract, meaning there's no payment upfront. You simply enter into 'a legal agreement to buy or sell a particular commodity asset, or security at a predetermined price at a specified time in the future'. Payment is made at delivery, not upfront.

If you "sell" that contract for a different futures price, the exchange simply voids your contract and gives you (or takes from you) the difference between your initial future price and the new future price.

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  • I know. The formula only works for non income, no storage costs asset. I put there that formula only for simplicity-sake. Lastly, I don't think you answered my question regarding the delivery cost. Oct 12, 2022 at 17:08
  • When the contract expires, you buy the asset at the predetermined price. Payment is made at delivery, not upfront
    – D Stanley
    Oct 12, 2022 at 17:32
  • Yes but let's suppose Gold's spot price is $100, gold's future price is $110 and the delivery price is $105. If I buy the contract today, I spend $110 and I will receive the asset. I won't have to pay an additional $105 to buy the asset. Where am I wrong? Oct 12, 2022 at 17:56
  • You can't enter into a future for a price different than the futures price. If you "buy" a gold future, the delivery price will be $110. Even then, you won;t spend $110 today - you're just entering into a contract. You'll pay $110 when the contract expires (unless you sell it)
    – D Stanley
    Oct 12, 2022 at 18:41
  • spoilage and other factors would factor into the cost of storage.
    – user253751
    Oct 13, 2022 at 12:30

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