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Current time:0:00Total duration:3:09

Video transcript

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 and the fair value tends to be quoted for the front month or the next expiring futures contract next expiring futures contract and to see how this works why someone would be neutral between say buying something now for $100 and agreeing to buy it maybe next month at 102 dollars 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 hundred dollars right now or they could put they could take their hundred dollars so they could either just buy it right now or they could stick it maybe in a money market account they could get some interest for the next few weeks and then they could buy the futures contract so if they got interest of two dollars if they kept that hundred dollars in a say a money market account for the next until the actual contract date for that futures contract they'd be neutral I could spend a hundred dollars today or I could put a hundred dollars in a money market account get two dollars 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 but assuming no dividends you'd say well or I'd be willing to pay a hundred two dollars for that if this was only a hundred one dollars if the price of the futures contract was 101 dollars then you'd say wait if the price of the futures contract is $101 I would rather I would rather put my money in a money market account get two dollars of interest and buy it in a month for 101 dollars I'll essentially get an extra dollar if I do that if the price if the price is 100 and if the price is at one hundred and three dollars did 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 100 three dollars and I'm a seller of the stock instead of selling it today for $100 I'm better and let's say I really need $100 right now I'm better off borrowing $100 right now paying maybe two dollars in interest and then selling it a month later for a hundred and three dollars so the fair value is the price at which a buyer seller is neutral between buying and selling the stock or entering into a futures contract I'll go into a normal bit more detail in the next video but its main use as an indicator of what's likely to happen once a market opens and that's because futures markets futures markets trade much have much longer trading hours sometimes 24 hours than traditional stock markets so if you can imagine if a price is 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 stock once the market opens that the stock price is going to go down