hello dax

While hedging has been the initiator of the existence of future markets, speculation became an important role for price driving on the markets . As soon as parties started to trade future contracts before it's settlement and delivery this new aspect came into being. Speculators were not anymore interested in the delivery of the underlying product but only speculate about it's value. So future contracts becoming a market like any other market of tradeable goods determined by ask and demand.

This arises the question how prices of futures and their underlyings mutually influence each other. I won't go deeper into this question, which is merely a question about market and price theories but it is generally seen that future prices tend to be higher than the underlying product, a difference known as "premium".

Factors influencing the premium of a future are the interest rate, the dividend yield when stocks are concernend and future expectations of the underlying which depends on the duration time of the future. The most comprehensive model on prices of futures being the Black and Scholes model based on perfect market theories.

These factors generally have positive values, with exception of the dividend yield which has a negative contribution, resulting in the premium a buyer (the long side) of a future contract has to pay. More about future prices.

In general the premium being the biggest at the opening of the future contract, tending to go to zero during it's lifetime and being exactly zero at settlement (at expiry date). This overall decreasing value of premium being one of the reasons a man like Soros preferes stocks and commodities over derivatives as futures because there is no such thing as premium involved with these.

Next time more on the various parties on the market and a comparison how they act.