Question

You are seeking for any arbitrage opportunity in June. The current market quotations are as follows.

CPO spot price is currently RM1,950 per metric ton July FCPO contract is trading at RM2,000 August FCPO contract is trading at RM 1,972 September FCPO contract is trading at RM 1,983 CPO Storage cost is RM5 per month and risk-free rate is 4%. Assume 100 metric tons of CPO.

a) Compute the fair value for the July, August, and September futures price. Then, show which of the three contracts is the best for implementing an arbitrage strategy, if there is any arbitrage opportunity.

b) The spot prices of CPO in the next three months are listed below. Calculate the arbitrage profit if you used arbitrage strategy in part (a) of this question.

CPO spot price at the end of July: RM1980 per metric ton CPO spot price at the end of August: RM1990 per metric ton

CPO spot price at the end of September: RM1998 per metric ton.

Answer 1

(a)

Fair Value of July FCPO contract = (Spot cost *(1+(0.04/12))) + Storage Cost

                                                         = (1950*1.003333)+5

                                                         = 1961.50

 

Fair Value of August FCPO contract = (Spot cost *(1+(0.04/6))) + Storage Cost

                                                          = (1950*1.00666)+5*2

                                                          = 1973

 

Fair Value of September FCPO contract = (Spot cost *(1+(0.04/4)))+Storage Cost

                                                               = (1950*1.01)+5*3

                                                                =1984.5

 

July contract is best for arbitrage strategy . There is maximum mismatch between fair value and actual Future price in July Contract.

b)

The Future price is higher than fair value. Hence for arbitrage , one should sell futures

Spot Price at the end of June =1980

          Hence Arbitrage Profit = 2000-1980

                                               = RM20 per metric ton