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How to Convert Futures Price to Cash Equivalent

Original post by Michael Wolfe of Demand Media

When a person chooses to invest in commodities, he will usually do so not by buying the commodity itself, but by buying futures contracts. These contracts that give the investor the right to ownership of the commodity at a future date. Yet, many investors are not prepared to take delivery of the commodities. Instead, when the contract expires, they will choose to settle it for cash with the supplier. The cash value of a contract is relatively easy to calculate, particularly close to the expiration date.

Contents

Step 1

Identify the futures price. In order to calculate the cash equivalent of a futures price, you must first identity how much you paid for the contract when you bought it. This price changes constantly. If you don't want the contract to expire and settle it in cash then, you can sell the contract on the open market at its current price and receive cash for it.

Step 2

Identify spot price. The spot price is the contract that a purchaser would pay for a particular commodity were he to purchase it at the point of sale. For example, if a purchaser chooses to take delivery of 10,000 barrels of oil in Lagos, Nigeria, then the price charged by the supplier in Lagos would be the spot price. Like the futures price, the spot price always changes.

Step 3

Take the difference between the two prices. When you choose to cash settle a futures contract, you are responsible for paying the difference between the current futures price and the current spot price. If the price of the contract has gone up since you bought it, you stand to make money on your investment; if it dropped, you will lose money, but you will still receive cash.

Step 4

Add in broker's fees. When choosing to cash settle a contract, you will generally not settle the contract yourself. Unless you have a commodities trading license you will have a commodities broker do it for you. When this happens, you will have to calculate how much the broker will charge you. Generally, a broker will charge you a set fee for the transaction that he will inform you of ahead of time.

Step 5

Add in taxes. In order to get a fully accurate idea of the value of your futures contracts, you will also need to calculate in any taxes you will be paying on the contract. While taxes are not always applied to the sale of commodities contracts, they will likely be applied if you made a profit on the sale. To know the current capital gains tax rate for your area, check with your state government and the Internal Revenue Service.


                   

References

  • "Mastering Futures Trading"; Bo Yoder; 2004

About the Author

Michael Wolfe has been writing and editing since 2005, with a background including both business and creative writing. He has worked as a reporter for a community newspaper in New York City and a federal policy newsletter in Washington, D.C. Wolfe holds a B.A. in art history and is a resident of Brooklyn, N.Y.


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