As with arbitrage, convergence trading has negative skew in return distributions it produces, resulting from the concave payoff characteristic of most such high-probability low-return strategies. Operators engaging in such trades will usually make consistent but relatively small profits, occasionally offset by significant losses, consuming previous profits earned over a long period of time. The low probability of encountering a loss in such strategies can lead inexperienced traders to underestimate the severity of such a loss, and assume excessive levels of leverage, potentially leading to bankruptcy as in the LTCM case.
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Hidden categories: Pages incorrectly using the Blockquote template. Namespaces Article Talk. Views Read Edit View history. Help Learn to edit Community portal Recent changes Upload file. Download as PDF Printable version. Personal Finance. Your Practice. Popular Courses. What Is Convergence? Key Takeaways Convergence is the movement in the price of a futures contract toward the spot or cash price of the underlying commodity over time. The price of the futures contract and the spot price will be roughly equal on the delivery date.
If there are significant differences between the price of the futures contract and the underlying commodity price on the last day of delivery, the price difference creates a risk-free arbitrage opportunity. Risk-free arbitrage opportunities rarely exist because the price of the futures contract converges toward the cash price as the delivery date approaches. Compare Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation.
This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace. Related Terms Understanding Cash Price The cash price is the actual amount of money that is exchanged when commodities are bought and sold in the real world. Backwardation Definition Backwardation is when futures prices are below the expected spot price, and therefore rise to meet that higher spot price.
Cash-and-Carry Trade Definition A cash-and-carry trade is an arbitrage strategy that exploits the mispricing between the underlying asset and its corresponding derivative. Crude Oil Definition and Investing Examples Crude oil is a naturally occurring, unrefined petroleum product composed of hydrocarbon deposits and other organic materials.
A commodity ETF is an exchange traded fund that invests in physical commodities, such as agricultural goods, natural resources, and precious metals. Carrying Charge Market Definition A carrying charge market is a futures market where long-maturity contracts have higher future prices, relative to current spot prices. Partner Links. Related Articles. Futures Price: What's the Difference?
Commodities Who Sets the Price of Commodities? Spot Rate: What's the Difference? ETF: What's the Difference?
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Another term for convergence trading is relative value trading or pairs trading. investmenttradeexchange.com › convergence-trading-arbitrage-and-systemi. Convergence trade is a trading strategy consisting of two positions: buying one asset forward—i.e., for delivery in future —and selling a similar asset forward for a higher price, in the expectation.