Definition
Fair Value (Futures)
Fair value is the theoretical price of a futures contract, equal to spot plus the cost of carry.
Fair value tells you what a futures contract should trade at given the current spot price, the interest rate, the time to expiry, and any expected dividends. The formula is essentially spot price plus financing cost minus dividends.
When the market futures price diverges from fair value, NSE arbitrageurs step in: trading above fair value invites cash-and-carry (buy spot, sell futures), and trading below it invites the reverse. For directional traders, the gap between market price and fair value also hints at sentiment — a futures premium well above fair value suggests aggressive longs.
Related terms
- Synthetic LongA synthetic long replicates owning the underlying by buying a call and selling a put at the same strike.
- ContangoContango is when futures trade above the spot price, the normal state reflecting the cost of carry.
- Cost of CarryCost of carry is the net cost of holding an asset to a future date, comprising financing cost less any income, and it determines the fair-value difference between a futures price and the underlying spot price.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.