Question

In: Finance

Suppose you notice that the April gold futures price is $1,520, while that for December is...

Suppose you notice that the April gold futures price is $1,520, while that for December is $1,540 (both prices are per ounce). Historically, this spread has been around $15. Suggest a trading strategy that you might set up in the hope that the spread would revert to its historical level next month.

( I need a clear and detail answer please)

Expert Solution

April gold future=$ 1520

December gold future=$1540

NormalSpread=$15

Expected December gold future=(1520+15)=$1535

Hence December Future is currently costlier.

Trading Strategy should be to buy cheap and sell at higher price

Trading Strategy:

Buy April gold future at $1520

Sell December gold future at $1540

It is expected that the spread will revert to $ 15 next month.

Suppose ,

Next month April gold future value is X

It is expected that December future will be X+15

If X is lower than $1520 (Say it is $1515),there will be loss of $5 in April future

But,the December future will be X+$15 (as per this assumption, it would be $1515+15=$1530)

There will be gain of $10(1540-1530)in December future.

Hence ,there will be net gain of (10-5)=$5

Now,assume :

X is higher than $1520 ,say $1525

The December future will be (1525+15)=1540

There will be gain of $5 (1525-1520) for buying April future.

For sale of December future will have no gain or loss.

Hence, there will be net gain of $5

jeff jeffy answered 2 years ago

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