Futures and Fair Value

[waza1960]

I would appreciate it if anyone could explain clearly the concept of Fair value as it pertains to Futures and the open of the underlying instrument.
I don't want the formulae to work out fair value as this is readily available .
I'm interested in the relationship to the open and close of said instrument and the relevance of Fair Value in this scenario.
I can't find a clear explanation on the net.

 

[skc]

I would appreciate it if anyone could explain clearly the concept of Fair value as it pertains to Futures and the open of the underlying instrument.
I don't want the formulae to work out fair value as this is readily available .
I'm interested in the relationship to the open and close of said instrument and the relevance of Fair Value in this scenario.
I can't find a clear explanation on the net.

Futures are contract to deliver the underlying at some future date. Fair value of a future contract is based on the concept of no arbitrage... that is, the price of the future contract should be eqivalent to the spot / cash market price + the cost of carry. Otherwise someone can buy the cheap one and sell the expensive one and earn risk free profits.

The cost of carry depends on the instrument. For stock index it would be interest and dividend drop offs, whereas for gold it would be cost of interest, storage, insurance etc.

The futures may not always be priced at fair value (compared to the spot market) due to short term variation and changes in market sentiment, but such gaps are typically small and closed over time due to arbitrage actions.

The open and close of the underlying instrument has no bearing on what fair value should be as far as I know...

 

[cynic]

I thought it might be an opportune time to bump this thread as it appears to address questions raised recently in another thread.