Voiceover: The fair value of a futures
contract is the price of the contract at which a buyer of the
stock would be neutral between buying it on in
an actual stock exchange and actually buying the stock and
agreeing to buy the futures contract. Or a seller of the stock would be
neutral between selling it right now in the actual exchange
versus agreeing to go short or agreeing to be on the selling
side for a futures contract. The fair value attends to be
quoted for the front month or the next expiring futures contract. Next expiring futures contract. To see how this works, why
someone would be neutral between say, buying something now
for a $100 and agreeing to buy it maybe next month at a
$102, think of it this way. If they want to just hold that stock
a month, or two, or three from now, they could pay a $100 right now
or they could take their $100 so they could either just buy it right now or they could stick it maybe
in the money market account. They could get some interest
for the next few weeks and then they could buy
the futures contract. If they got interest of $2, if they kept
that $100 say in a money market account for the next, until the actual
contract date for that futures contract they'd be neutral. I could spend a $100 today or I could
put a $100 in a money market account, get $2 in interest and I'm not going
to worry about the dividends right now. If a dividend happens then, obviously
you would want to pay less for this thing where you didn't get the dividend. Assuming no dividends, you say well or
I'd be willing to pay a $102 for that. If this was only a $101, if the price
of the futures contract was a $101, then you say, "Wait, if the price
of the futures contract is a $101," "I would rather put my money in a money
market account, get $2 of interest." "And buy it in a month for a $101." I'll essentially get an
extra dollar if I do that. If the price is at a $103, you say,
"Well gee, if I want to hold that stock" "a month or two from now. I'm
way better buying it right now." Or another way to think about
it if the price is at a $103 and I'm a seller of the stock. Instead of selling it today for a $100, let's say I really need a $100 right now. I'm better off borrowing a $100 right now. Paying maybe $2 in interest and then
selling it a month later for a $103. The fair value is the price which
a buyer or seller is neutral between buying and selling the stock
or entering into a futures contract. I'm going to go a little bit
more detail in the next video but it's main use is an
indicator of what's likely
to happen once a market opens and that's because futures markets
trade have much longer trading hours, sometimes 24 hours than
traditional stock markets. If you could imagine, if the
price of a futures contract is trading below its fair value, the only reason why that would happen is if a lot of people are actually
expecting, once the market opens that the stock price is going to go down.