What is the underlining difference between the spot market and the future’s market?
The difference is a discounting function based on the risk-free rate. Therefore if you’re long the cash market (stocks in this case) and short futures the difference has to be the mimumium required return on cash. Which is the risk-free rate.
If r = 10%
and So = 1k
Fp = So(1+r)^n
Fp = 1,000(1.10) = 1,100
resolve for r being short the 1,100 and long the 1000
1,100 = 1,000(r)
r= 10%
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You’re anticipating the short position in the 1,100 notional value will converge to the 1,000 in the cash marekt. The difference of 100 will be your ‘profit’ which is just simply the risk-free rate of return the market expects you to make on cash positions. You’re not going to realize any capital gains from increases in the stock market as this same increase is reflected in your short futures position. You’re technically arbing out all equity return component which leaves you with the risk free rate of return.
Think of the stock market as a cash position (they actually call it a cash market in the real world) and it’s much easier to understand.