Personal Finance & Money Stack Exchange is a question and answer site for people who want to be financially literate. It only takes a minute to sign up.
Sign up to join this community
At the time of writing:
According to Kitco, the spot price for gold is about $1240 per ounce.
According to CME Group, futures contracts are above that price for many months ahead.
Why couldn't I buy an ounce of gold at the current spot price of $1240 and sell a futures contract for August 2014 at $1256, hold it until it expires, and guarantee myself a 16 dollar profit?
Am I missing something here? Why don't more people do this?
You're missing the cost-of-carry aspect:
The cost of carry or carrying charge is the cost of storing a physical commodity, such as grain or metals, over a period of time. The carrying charge includes insurance, storage and interest on the invested funds as well as other incidental costs. In interest rate futures markets, it refers to the differential between the yield on a cash instrument and the cost of the funds necessary to buy the instrument.
So in a nutshell, you'd have to store the gold (safely), invest your money now, i.e. you're missing out on interests the money could have earned until the futures delivery date. Well and on top of that you need to get the gold shipped to London or wherever the agreed delivery place is.
Edit:
Forgot to mention that of course there are arbitrageurs that make sure the futures and spot market prices don't diverge.
So the idea isn't that bad as I might have made it sound but being in the arbitrage business myself I should disclaim that profits are small and arbitraging is highly automated, so before you spot a $1 profit somewhere between any two contracts, you can be quite sure it's been taken by an arbitrageur already.
As proposed:
Buy 100 oz of gold at $1240 spot = -$124,000
Sell 1 Aug 2014 Future for $1256 = $125,600
Profit $1,600
Alternative Risk-Free Investment:
1 year CD @ 1% would earn $1240 on $124,000 investment. Rate from ads on www.bankrate.com
"Real" Profit All you are really being paid for this trade is the difference between the profit $1,600 and the opportunity for $1240 in risk free earnings. That's only $360 or around 0.3%/year.
Pitfalls of trying to do this:
Many retail futures brokers are set up for speculative traders and do not want to deal with customers selling contracts against delivery, or buying for delivery.
If you are a trader you have to keep margin money on deposit. This can be a T-note at some brokerages, but currently T-notes pay almost 0%.
If the price of gold rises and you are short a future in gold, then you need to deposit more margin money. If gold went back up to $1500/oz, that could be $24,400. If you need to borrow this money, the interest will eat into a very slim profit margin over the risk free rate.
Since you can't deliver, the trades have to be reversed. Although futures trades have cheap commissions ~$5/trade, the bid/ask spread, even at 1 grid, is not so minimal. Also there is often noisy jitter in the price. The spot market in physical gold may have a higher bid/ask spread.
You might be able to eliminate some of these issues by trading as a hedger or for delivery. Good luck finding a broker to let you do this... but the issue here for gold is that you'd need to trade in depository receipts for gold that is acceptable for delivery, instead of trading physical gold. To deliver physical gold it would likely have to be tested and certified, which costs money. By the time you've researched this, you'll either discover some more costs associated with it or could have spent your time making more money elsewhere.
Even if you did this and there were no other costs or risks involved, you might actually make a loss in real terms due to inflation.
If the purchasing power of $1240 today is greater than the purchasing power of $1256, 13 months in the future, that means you are making a loss with your arbitrage. It's not a get-rich-scheme even if it works.
