A:

The fair value is the theoretical calculation of how a futures stock index contract should be valued considering the current index value, dividends paid on stocks in the index, days to expiration of the futures contract and current interest rates.

How to Calculate Fair Value

Fair value can show the difference between the futures price and what it would cost to own all stocks in that index.

For example, the formula for the fair value on the S&P futures contract is:

Fair value = cash * {1+r(x/360)} – dividends

(Cash is the current S&P cash value, r is the current interest rate that would be paid to a broker to buy all the stocks in the S&P 500 index, and dividends are the amount of dividends until futures contract expiration expressed in terms of points on the S&P contract.)

Fair Value Versus Futures Price

This value is often shown on financial television and displayed online before the equity markets open for trading. The fair value can provide a glimpse of overall market sentiment. The futures price may be different from the fair value due to the short-term influences of supply and demand for the futures contract. The fair value always refers to the front-month futures contract, as opposed to a further out month contract.

This difference between the fair value result and the current S&P 500 futures price may represent an arbitrage opportunity for those assuming that the futures price will eventually revert back to the fair value price.

The fair value and futures price will fluctuate during the course of the trading day. The futures contract trades on the Chicago Mercantile Exchange, while the individual stocks as components of the S&P 500 are trading at dispersed stock exchanges around the country. As such, there are often discrepancies between the two.

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