Question

Problem 2.31. Suppose that there are no storage costs for crude oil and the interest rate for borrowing or lending is 5% per annum. How could you make money if the June and December futures contracts for a particular year trade at $50 and $56?You could go long one June oil contract and short one December contract. In June you take delivery of the oil borrowing $80 per barrel at 5% to meet cash outflows. The interest accumulated over six months is about 50×0.05×1/2 or $1.25. In December the oil is sold for $56 per barrel which is more than the $51.25 that has to be repaid on the loan. The strategy, therefore, leads to a profit. Note that this profit is independent of the actual price of oil in June and December. It will be slightly affected by the daily settlement procedures.

Answer 1

You could go long one June oil contract and short one December contract. In June you take delivery of the oil borrowing $50 per barrel at 5% to meet cash outflows. The interest accumulated in six months is about 50×0.05×0.5 or $1.25. In December the oil is sold for $56 per barrel and $51.25 is repaid on the loan. The strategy therefore leads to a profit of $4.75. Note that this profit is independent of the actual price of oil in June or December. It will be slightly affected by the daily settlement procedures.