Question

Suppose that there are no storage costs for greasy wool and the interest rate for borrowing or lending is 3% per annum. The greasy wool futures contract for December 2012 is quoted at AUD 9.55 per kilogram, while the June 2013 contract is quoted at AUD 9.89 per kilogram. One contract is for delivery of 2500 kilograms. How could you make money by trading the December 2012 and June 2013 greasy wool futures contracts today?

Answer 1

The December 2012 settlement price for greasy wool is AUD9.55 per kilogram. The June 2013 settlement price for greasy wool is AUD9.89 per kilogram. You could go long on December 2012 greasy wool contract and short on June 2013 contract. In December 2012 you take delivery of the greasy wool borrowing AUD9.55 per kilogram at 3% to meet cash outflows. The interest accumulated in six months is about 9.55*2,500*0.03*6/12 or AUD385.13 per contract. In June 2013 the greasy wool is sold for AUD9.89 per kilogram which is more than the amount that has to be repaid on the loan. The gain from the buy/sell transaction is (AUD9.89 - AUD9.55)*2,500 = AUD850 per contract. Hence, the strategy leads to a profit of AUD850-AUD385.13=AUD491.87 per contract. Note that this profit is independent of the actual price of greasy wool in June 2013 or December 2012. It will be slightly affected by the daily settlement procedures.