554 Part V: Index Options and Futures 
Commissions on futures are generally charged only when the position is closed 
out. Generally, a futures commission on an S&P 500 contract might be reduced to 
something like $10 per contract for this type of hedging. Since 185.00, the index 
value, represents 11500th of the value of the futures contract, we can reduce the 
futures commission to an index-related number by dividing the actual dollar com­
mission by 500. Thus, the futures commission is, in index terms, 10/500, or .02. The 
total commission for entering and exiting the position is thus 0.266 of index value, 
0.123 each for the purchase and sale of the stocks and .02 for the futures. 
Net profit = Futures 
price 
Futures fair Commission 
value costs 
= 188.50 - 187.00 - 0.27 
= 1.23 
This absolute net profit number can be converted into a rate of return by annualiz­
ing the profit and dividing by the current index price. Suppose that there are 
two months exactly remaining until expiration. Then the rate of return is computed 
as follows: 
Incremental = Net profit x ( 1/Time remaining) 
rate of return Index price 
1.23 X ( 12/2) 
185.00 
= 3.99% 
For the two-month time period, his return is about 2h of one percent. 
At first glance, a rate of return of almost 4% does not seem like much. But what 
we have computed here is an incremental rate of return. That is, this return is over 
and above whatever rate we used in determining the fair value of the futures. Thus, 
if an institution were going to invest its cash at the prevailing short-term rate, and that 
rate were used to determine the futures fair value in the above example, then the 
institution could earn an additional 4%, annualized, if it arbitraged the futures rather 
than put its money in the short-term money market. 
TRADE EXECUTION 
Most customers are not concerned with how the trades are executed, for they give 
the order to their broker and let him work out the details. However, for those who 
are interested in the actual trade execution, a short section dealing with that topic is 
in order.