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Answer: Futures prices may vary widely from the spot price of the underlying asset, but the two prices will typically converge as a futures contract approaches maturity
A is correct. Futures prices typically converge toward the spot price of the underlying asset as a futures contract approaches maturity. This is due to the arbitrage activities of market participants who take advantage of price discrepancies between the futures and spot markets. Arbitrageurs will play a vital role in the convergence of futures prices and underlying spot prices during the delivery period. They do this by engaging in arbitrage trades that exploit the price differences, thus ensuring that the futures price and the spot price remain close to each other. Option B is incorrect because it does not specify the delivery period, which is crucial for the convergence process. Option C is incorrect because if the futures price is above the spot price during the delivery period, an arbitrageur would sell the futures contract and buy the asset in the spot market to profit from the price discrepancy, not the other way around. Option D is incorrect because the S&P 500 futures contract is cash settled, meaning there is no physical delivery involved, and thus no trading activity related to taking physical delivery.
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A junior trader at an investment firm is analyzing the structure of futures markets along with the corresponding spot markets for the underlying assets. The goal is to identify any correlations in the price movements between these markets and to propose specific trading strategies that leverage these correlations. What is the correct statement about the relationship between futures prices and spot prices?
A
Futures prices may vary widely from the spot price of the underlying asset, but the two prices will typically converge as a futures contract approaches maturity
B
Arbitrageurs keep the futures price and the underlying spot price close to each other throughout the life of the contract.
C
If the futures price is above the underlying spot price during the delivery period, a trader can profit by buying futures contracts and selling the underlying asset in the spot market.
D
The S&P 500 futures contract has the most trading activity of any futures contract due to its requirement to take physical delivery on the delivery date.