Why Futures Prices Usually Reflect Carry Costs, Not Expectations

# Does a future contract's price show where investors think the underlying asset's price would be?


# Does a future contract's price show where investors think the underlying asset's price would be?












When the price of an asset's future contract is at a certain level, does that mean investors as a whole expect the actual underlying asset to reach that price level in the future?

## Answer by nbbo2 (score 1, accepted)

https://quant.stackexchange.com/a/52927

It depends. But generally for a storable commodity and as long as there is no shortage of storage capacity or temporary problems with the supply of the spot commodity, the answer is NO.

Gold is an example. You have $F > S$ but that is because of the financing and storage cost of buying gold and delivering it in the future, rather than because of an expected future appreciation. We say that the Future price is determined by "Cash and Carry Arbitrage". Stock Index Futures (and financial futures in general) also follow this simple relationship.

If you have a product that cannot be stored, such as a perishable food crop, the answer might be different and the Spot and Future prices can become decoupled and the mathematical relationship breaks down. Expectations of the future crop become important.

Also, there have been times in the Crude Oil market when the World did not have enough space to store all the unsold crude, so the arbitrage relation could not take place.

Finally there are sometime "spot shortages" for a commodity like Copper where factories need Spot copper for immediate use and buying futures does not solve their problem. In this case again the two markets can become decoupled with $S > F$.

But the most common case is F slightly higher than S as a result of interest rates and storage, insurance and other handling costs, with no role for price expectations.

(Nevertheless many people think F is typically determined by investor expectations, even some fairly sophisticated people. Probably the reason is historical. The futures markets were created in Osaka Japan and later Chicago IL to price a new crop of rice (or wheat) which will not even exist until year (or more) from now, here expectations are indeed key. But most futures markets nowadays are not of this kind. Most futures markets today deal in the deferred delivery of an existing, easily storable product.)

## Answer by JerryFrog (score 1)

https://quant.stackexchange.com/a/52970

For a purely financial product, with no pent-up investor sentiment for buying or selling (i.e. no supply/demand concerns), the futures market is purely a function of the discounted cash flow in 'carrying' the current spot price forward. Now, if markets are efficient, today's product spot price is a function of the discounted expectation for future cash flows, and so, if markets are efficient, logically, the two markets should be in kilter.

## Answer by FridaTheDog (score 0)

https://quant.stackexchange.com/a/52944

The answer is that it depends on the asset. If you were thinking of commodities (e.g., oil), it is a common misconception to think that the future contracts reflect market expectations. For these, prices simply reflect what is called the cost of carry, or the cost of carrying the commodity to that certain future point