On January 31, 2013, the futures contract on unleaded gasoline (NYMEX) with 6 mo

Question

On January 31, 2013, the futures contract on unleaded gasoline (NYMEX) with 6 months to maturity, were trading for $3.03 per gallon. Assume that the cash price was $2.83 per gallon and that the (annual) 6 month interest rate was 6 %.

a) Compute an estimate of the cost-of-carry for heating oil during the period. Discuss the different components of cost-of-carry.

Assume that your estimate of cost-of-carry above is valid. Then you suddenly observe that the spot price drops to $2.60 per gallon. Assume that the futures price remains constant at $3.03 per gallon.

b) What would you do?

Explanation / Answer

Cost of carry is the cost of maintaining an asset, foreg non financial assets like commodities need msaintainance costs to retain its quality and value

The cost of carry or carrying charge is the cost of storing a physical commodity, such as grain or metals, over a period of time.

The present value of 6 month future is 3.03×e^(-0.06×0.5) = 2.94$

And the cash value is 2.83$, so the costof carry is 2.94-2.83 = 0.11$,

Cost of carry can be heating oil, maintaining quality using tight storage containers etc.

B.If the spot rate drops to 2.60$, then there is good arbitrage opportunity, we can short 6 months future and long on spot to gain arbitrage profit

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