What is Premium and Discount in Futures Market?

If you are a regular follower of our site, you would be introduced to the basic concept of futures and options market at the beginning. Today’s topic Premium and Discount in Futures Market also comes under basic knowledge. This article will help newbies in understanding the premium and discount in futures market. In order to understand the concept, you must be aware of the difference between the spot and future market.

Now, let’s have a quick look at what the futures and spot prices are in the market. The spot price reflects the immediate settlement of security while futures prices delay the payment and delivery to predetermined future dates.

What is Premium and Discount in Futures Market?

Now, come to the most commonly used market terminology– Discount and the Premium.

When the future price is trading higher than the Spot price, this is the natural order of things, the specific futures market is said to be at “Premium”. In this case, one thing should be clear that the term “premium” is used only in the Equity derivatives market. The commodity derivative market refers to the same phenomenon as “Contango”. So, both contango and premium indicate the same fact, the futures are trading higher than the spot.

Premium: Future price – Spot price

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On the other hand, Discount is when the spot price exceeds the futures price. The situation is also referred to as backwardation in the commodity derivative market while equity derivative market refers to it as Discount. When the futures price is to converge with the spot price, the situation is considered as normal.

Discount: Spot value – Futures price

Example:

Suppose currently Nifty is trading at 5000 and Nifty futures is trading at 5050. Here, Nifty is trading in Premium of 50 points (5020-5000)=50

Now, if the situation is Nifty is trading at 5000 and Nifty futures is trading at 4990. Here, Nifty is trading in trading at a discount of (5000-4990)=10 points.

Premium and Discount Market Strategy

There are some common market strategies on premium and discount in the Futures market.

  • In the case of widens Discount, Bearish market increase.
  • In the case of widens Premium, Bullish market increase.
  • At the closing date of futures, Premium, and Discount converges to zero.

These are some of the basic concepts regarding futures Premium and Discount market strategy.



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