Article – 3: Commodity forwards and Futures. (Robert McDonald)

In this article, we will discuss about asset holding positions. All these points are basic points, but we need to understand these basics before discuss about the topic in depth.

Variables	How they are denoted?
Present price of an asset	Spot price (S0)
Expected future price of an asset, after a time ‘T’	F0,T
Holder of an asset (presently or referring to spot market)	A trader with long position
Seller of an asset  (Presently or referring to spot market)	A trader with short position
If the holder of the asset agrees to sell in future and enters into an agreement	Then, his position is denoted in forward markets as: Short forward position
If an investor wishes to buy the asset in future	Then, his position is denoted in forward markets as: Long forward position
If an investor borrows an asset from an holder and sells it in the spot market. (Please understand that he is expecting that in future the prices would come down and he can repurchase the asset at a lower price)	A short sale position
Dividend yield ( Dividend yield is an income for the holder of the asset)	δ
Convenience yield	λ
Information about convenience yield: Generally companies hold the commodities for their working capital needs and they know in future it would be very difficult to acquire the assets either due to shortage or due to price increase. For example, a steel manufacturer knows that it is better to store the commodity, even though it causes storage cost. The advantage to the manufacturer, when compared to other manufacturers is, he can avoid shortage of material. Therefore, such holders of assets enjoy the convenience of holding the assets. Therefore storage of commodities offers a convenience to the holder of asset. That convenience is expressed in yield or return  terms as “Convenience yield”.

From tomorrow onwards, we will discuss deeply on topic: COMMODITY FORWARDS AND FUTURES, BY Robert McDonald.

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