Chuckrox

You do not need cash to go long the S&P Futures contrct , or at least very little of it. You just need margin which is frequently ignored in the calculations. So there is not much borrowing going on if you use Futures . While there is full borrowing if you invest in stocks in the index.

The futures price however builds in the risk free rate as well . So it is higher than the spot price , i.e. F=S*(1+r)^t holds under no-arb, no storage, no convenience condition.

At convergence i.e. expiry , the Futures price=Spot price.

So the implied rate of return on the futures contract is lower than the direct return on the stock index , given all the above conditions.

implied Futures return + Risk Free rate = cash index return.

or implied Futures return = cash index return - Risk free rate .

Hence the statement that you gain the cash index return and give up the return on cash i.e. the risk freee rate.



Edited 1 time(s). Last edit at Sunday, April 24, 2011 at 07:04PM by janakisri.