When Trading Futures, What’s Priced in?

by Matt Krupski

When trading futures, it is important to ask yourself the question of: “What’s priced in?” The concept of something being “priced in” refers to the fact that prices for futures do not reflect only current economic realities, but the expectation of market conditions at some point in the future. This concept is important to understand, particularly when considering seasonal trading strategies. For instance, in winter, most investors expect the demand for heating oil to increase.

Basic economic theory tells us that as demand increases, price increases. If you look at the term structure of heating oil (the prices of heating oil for different months of the year), you will see this economic assumption already “priced in.” Prices for winter delivery of heating oil are higher than prices for summer delivery of heating oil.

This structure is derived from basic market mechanics as well; if the summer-month contracts and winter-month contracts were trading at the same price, people would buy the winter months and sell the summer months in anticipation of winter price increases. This buying would drive up the price of the winter months, and the selling would drive down the price of the summer months until the market reached equilibrium where most investors felt the market was fairly priced.

The concept of things being “priced in” holds in other markets as well. Futures on the stock market reflect not only current realities, but the expectations of future earnings and economic conditions. Gold futures are affected by not only current inflation expectations, but expectations of future inflation. That doesn’t mean that markets are always perfectly priced, or that there isn’t opportunity. Fundamentals can quickly change. But before making a trade, it is always good to verify that your expectations are different from what is already “priced in.”

Feel free to contact me with any questions you might have about trading, and how to incorporate some of these concepts into specific trading strategies for the markets today.

Matt Krupski is a Senior Market Strategist with Lind Plus. He can be reached at 877-847-3034 or via email at mkrupski@lind-waldock.com.

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