FINANICAL ANALYSIS

Forward Curve & Arbitrage

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Forward Curve & Arbitrage

Forward Curve and its Behaviours

'Forward curve' term is used to refer to a series of sequential prices for anticipated future settlements of an index as well as for asset's future delivery (Platts, 2012, p.2). The dynamic of market is complicated and affected by several factors, therefore in order to negotiate future delivery prices of commodities, it is essential for market participants to analyze future markets. Where, future markets can be analyzed by using the forward curves and specifically its structure (PVM, 2011, n.d).

Furthermore, research indicates that the curve which represents the desirable market price and is willing to transact the future business today is known as forward curve, and that the forward curve is simply a way which is used to analyze the time value of money. Thus, the forward curve is used by market participants as it reflects their perception and their expected trend of price.

Example:

Considering the natural gas markets of NYMEX, it is noted that market participants can enter into agreements for purchasing future deliveries of natural gas for fixed rates. An example can be taken here: a contract for delivery of natural gas is settled recently at $2.3125 in June, $2.519 in July, and $2.6445 in August, and so on. If these future prices of natural gas are listed in a table and then graphed, then they would look like this:

Table 1: Future Prices

(Source: Platts, 2012, p.2)

Graph 1: Forward Curve

(Source: Platts, 2012, p.2)

The above graph shows the collection of prices over the future periods of time, which is known as forward curve due to the shape it, takes on a graph. Any commodity that has forward market may associate a forward curve, where the reliability and availability of that forward curve is highly based on the liquidity of market at each forward month. Furthermore, the data of market can come from various sources, such as regulated exchanges, indications of trader, statements of broker, or third party data distributors as well as publishers (Platts, 2012, p.2).

Moreover, the data of forward curve can be different from different data sources, where this difference is commonly associated with the insights of market available to a specific source of data. For example, an exchange can quote a marketplace in multiple month 'strips' whereas a publisher of third party data can quote each month within those strips depends on over the counter data unavailable to the exchange.

An example is depicted by the table given below (Table 2), which represents the Social Gas basis swaps that were recently quoted by a publisher of market data as well as an exchange. The apparent difference is that the publisher of data had monthly quotes available while the exchange quoted the first 5 months as a single strip. Where, the remaining month differences are associated with the available data and liquidity. Thus, the source of data for market participants of future contracts impacts the future prices and consequently the future curve behaviour.

Table 2: Differences Due ...