One of the important things that makes futures markets work is the use of arbitrage by speculators. For wheat contracts within a single crop year the difference in prices for different maturity dates is equal to the carrying (i.e., storage) costs. A speculator knows that the usual carrying cost of wheat is about $0.02/bu/month plus a $0.02/bu placement fee. Therefore, one would expect the December wheat contract to be priced at the September contract plus $0.08. At present (in June), both contracts are trading at the exact same price, $3.75/bushel. This presents an opportunity for temporal (i.e., across time) arbitrage.
(a) Given this price abnormality, there is an opportunity for the speculator to profit from temporal arbitrage. The arbitrager would simultaneously make trades in the September and the December wheat futures markets. What position would be taken in each market?
(b) What is the effect of these trades (and those of similar speculators) on the prices of the two contracts?
(c) Assume that by August the usual $0.08 spread between the September and December contracts has returned. If the price of the September contract has fallen to $3.50/bu and the speculator closes out both positions, what has he or she gained?
(d) Assume that by August the usual $0.08 spread between the September and December contracts has returned. If the price of the September contract has risen to $3.90/bu and the speculator closes out both positions, what has he/she gained?