Different Tools, Different Rules

The principle of indifference is easy to ignore, but it's central to the pricing of all markets, including exchange-traded futures and options . A sound understanding of how futures markets are priced relative to their underlying assets, and of how futures and options differ in their risks and returns, will be essential for your success when single-stock futures, or SSFs, launch in about March 2002. Let's look at some important concepts.

Basis or Fair Value

If short-term interest rates are 2%, we should be indifferent between $1 today and $1.02 a year from now. If we tie up $10,000 in a stock, we're forgoing this rate of return, so we should be indifferent between paying $10,000 today or $10,200 to take delivery on an SSF one year from now. However, let's say this stock has a dividend yield of 1%, or $100. The owner of the stock receives the dividend, but the long position in an SSF does not, so the long position in an SSF will reduce the bid by the future value of this $100. ...