Expectation Approach

The Expectations Approach posits that the futures price reflects the market's consensus of the expected future spot price. Under this theory:

[ F = E(S_T) ]

Where:

• F: Futures price
• E(S_T): Expected spot price at maturity T

This approach assumes that futures prices are unbiased estimators of future spot prices, implying no systematic profit opportunities from trading futures contracts.

Difference Between Spot Price and Futures/Forward Price: Basis

The Basis is the difference between the spot price of an asset and its corresponding futures price:

[ \text{Basis} = \text{Spot Price} - \text{Futures Price} ]

• Positive Basis: Indicates backwardation, where the spot price is higher than the futures price.
• Negative Basis: Indicates contango, where the futures price is higher than the spot price.

Example:

If the spot price of gold is $1,200 per ounce and the futures price for delivery in three months is $1,250 per ounce:

[ \text{Basis} = 1200 - 1250 = -50 ]

This negative basis of $50 indicates a contango market.