Commodity futures fair value
|Fair value for dummies|
|Want to anticipate the market open? Understanding fair value can help
By Staff Writer Jake Ulick
|NEW YORK (CNNfn) - Business jargon comes and goes, moving like any fad to the commonplace from the obscure and back to obscurity.
Remember the corporate raider? And then there were junk bonds.
The latest entry: "fair value, " a phrase fast gaining currency in the world of business journalism.
Investors itching to know how the stock market might open get fair value quotes alongside financial staples like the dollar, the 30-year bond and the price of light sweet crude.
But what is fair value? And why does it matter? Read on.
Predicting the futures
Understanding the term begins with getting a handle on the relationship between a futures contract - in this case the S&P 500 futures contract - and the underlying commodity that the contract's value is derived from. In this case that's the S&P 500 index of large company stocks such as Microsoft (MSFT: Research, Estimates), General Electric (GE: Research, Estimates) and Merrill Lynch (MER: Research, Estimates).
Whether it's pork bellies, interest rates, or the S&P 500, buying or selling a futures contract represents making a bet on the future direction of the underlying commodity. The Chicago Mercantile Exchange, the big futures market where the S&P contract trades, even allows institutions to take positions on the weather in nine American cities.
An agreement to buy or sell the S&P futures amounts to a bet on how the index of stocks will behave over time. And like any financial security, its value changes moment to moment based on what traders will pay for it.
Launched in 1982 by the Chicago Mercantile Exchange, the contracts expire in March, June, September and December, with the most active trading done in the near-month contract.
And because the contract's terms are settled at a future date, the price of the contract generally leads the price of the index on expectations that S&P 500 stocks will do what they have done in the years past: rise.
So too with another contract emerging as a pre-market indicator: the Nasdaq 100 futures contract. The derivative of the 100 biggest stocks in the Nasdaq market also trades at the Chicago Mercantile Exchange.
Jack Cafferty, anchor of CNNfn's Before Hours, recently reported on both on the Nasdaq and S&P contracts, fair value, and their impact on the upcoming market...