Elsevier

Journal of Financial Economics

Volume 3, Issues 1–2, January–March 1976, Pages 167-179
Journal of Financial Economics

The pricing of commodity contracts

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Abstract

The contract price on a forward contract stays fixed for the life of the contract, while a futures contract is rewritten every day. The value of a futures contract is zero at the start of each day. The expected change in the futures price satisfies a formula like the capital asset pricing model. If changes in the futures price are independent of the return on the market, the futures price is the expected spot price. The futures market is not unique in its ability to shift risk, since corporations can do that too. The futures market is unique in the guidance it provides for producers, distributors, and users of commodities. Using assumptions like those used in deriving the original option formula, we find formulas for the values of forward contracts and commodity options in terms of the futures price and other variables.

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I am grateful for comments on earlier drafts by Michael Jensen, Myron Scholes, Edward Thorp, and Joseph Williams. This work was supported in part by the Center for Research in Security Prices (sponsored by Merrill Lynch, Pierce, Fenner & Smith Inc.) at the Graduate School of Business, University of Chicago.

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