Usually Futures contract price for near month, next month and far month is higher than spot price. Yesterday in Nifty I came across a case wherein March 29-oct-2015 contract was trading at 8268.70 and Nifty was at 8273.55. Even today March Futures is trading below nifty index price. What is the reason behind it and what can one derive from it? Also what is impact of positive and negative cost of carry? suppose the cost-of-carry is 4 or 2 or -1 or -3 and so on.
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1 Answer
There is an arbitrage relationship between the spot and the futures. The theoretical price of the futures is the spot, plus interest, minus the dividends, with both calculated until futures contract expiration. In a low interest rate environment, this theoretical value is normally below the spot, and is referred to as a discount. You can not infer anything if the spread between futures and spot is around the fair value.
If intraday trading results in the discount being much larger, then arbitrageurs step in and buy futures and sell stocks. If intraday trading results in the discount being much smaller, or futures move to enough of a premium, then arbitrageurs sell futures and buy stocks. This is known as program trading.
I'm not sure what the fair value is for Nifty, as I'm in the US, but you can see the daily values for the SP500, Nasdaq100 and Dow30 at Indexarb.com