Futures Contract - Value versus Price

[dennis_cmpe]

My co-worker and I we're having discussions about calculating the market value of a future.

We determined that the market value of a future was actually just the current variation margin of the futures contract (e.g. If money is owed - margin call is required).

So I got confused...in FRM last year we talked about calculating the price of a future (cost of carry-model, F=Se^rt, etc.).

These questions came up:

1) How come the futures price formula does not represent the market value?

2) Why is there a distinction between price and market value?

 

[David Harper CFA FRM]

Dennis,

Your (2) is always a source of confusion, in Hull at least. He uses (f) for forward value [p 107 7th ed] and (F) for forward price. Such that future value (f) = F - delivery price, or f[future] = F-K such that f[present] = (F-K)*exp(-rt); i.e., (F-K) but discounted to PV. In short, price (F) is the forward price that changes; i.e., what the long position expects to receive in exchange for the fixed delivery price (K), but value (f) is the "net" transaction; i.e., what's left after the long delivers (K) and receives the future spot asset (where best estimate of future spot price = forward price). So, at any inception for any derivative i can think of, generally we say the *value* of the contract must be zero (future expected spot price received - settlement price to be paid = 0) in order to engage both counterparties into a fair deal but the price of either "leg" will be $X.

I think (1) then has a couple of answers depending on meaning. On one level, we're saying the mark-to-market value is a net function of the traded future price; i.e., the value of the contract to me is the (expected) price of the asset I expect to recieve minus the price of what I plan pay to get it. On another level, the traded price can vary from the model price. F=S*exp(rt) is just a simplified cost of carry model, it gives expected forward price as function of forward price owing to the articulated fundamental variables. The traded price will impound other factors (technical factors and non articulated fundamental variables) like supply/demand, so we don't expect the model price to equal exactly the market price. In the cost of carry, one theory is that convenience yield is the "plug variable" that impounds all inarticulated factors.

"We determined that the market value of a future was actually just the current variation margin of the futures contract"
I never heard that before, but I see and agree with the logic of this, very cool! Yea, value = cumulative variation sounds right to me!

David