range of commodity futures no-arbitrage prices

CFA Level III Derivatives
#1

hi

lower limit considers convenience yield, upper limit does not

so can i say that only a arbitrageur who can realise the convenience yield can do reverse cash and carry & pay the lower limit but one who cannot realise the convenience yield will do cash and carry& pay upper limit?

is this how it should be interpreted?

thanks!

#2

Cash-and-carry: buy in the spot market, sell in the forward market, hold, deliver.

Reverse cash-and-carry: borrow underlying, sell in the spot market, buy in the forward market, take delivery, return underlying.

In cash-and-carry you benefit if you receive a convenience yield, because you hold the commodity. In reverse cash-and-carry you don’t benefit from a convenience yield, because you don’t hold the commodity.

Methinks you have it backward.

#3

s2000, ur answering almost every question of mine. thanks man!

i type out the range

Spot * e(Risk free + storage - convenience) * time < Foward price < Spot * e(Risk free + storage) * time

we look at it separately

Spot * e(risk free + storage - convenience) * t < Forward. anytime the inequality reverses, we have an arbitrage opportunity.

Spot * … > Forward -------> this implies that the forward is too cheap. and spot too expensive. So we LONG forward and SHORT spot --------------> Reverse Cash & Carry.

do the other side of the inequality and its Cash & Carry.

CORRECT???

#4

my previous post does not even answer anything. i get what u meant s2000

#5

The answer to your question is that the convenience yield is only available to those who have an alternate use for it ( for crude oil it could be having it to refine it into gasoline and diesel etc ) . The arbitrageur has no use for it , so he doesn’t derive a convenience yield from the commodity .

Although the equation shows you an arb may be available it is only available to a hedger not the speculator/arbitrageur . And the hedger 's mission is not to derive arbitrage profits but simply to offset risk.

The price is set in between the lower limit and the upper , but only because the hedger demands the convenience yield

#6

I try.

My pleasure.