Futures contracts have expiration dates. As such, each futures contract is assigned a specific contract month and year. The following are important concepts related to contract months:
- Futures for different commodities, not only have different expiration dates, but quantity of contracts per year differs as well. For example, the ES market has 4 contracts per year: Mar, Jun, Sep & Dec, while Crude Oil by comparison has 12 contracts per year: one for each calendar month.
- Multiple contract months of the same commodity are available to be traded at a given time, but liquidity will vary per contract month. The current contract month (also referred to as: front-end month) is likely to have the greatest liquidity (as compared to other “far-end” contract months); please be aware that commodities about to expire often become illiquid.
- Cost of Carry - Prices generally differ for each contract month. One major component affecting the difference in price of a commodity is the “cost of carry”. This term encompasses: storage, interest, and insurance. The “carrying costs” are factored into the price, so in a “normal” market, far-end contracts will generally be priced higher.
- Supply and Demand - Although carrying costs are a significant component in determining price, there are other factors involved, such as: supply and demand. Supply and demand play an important role in the valuation of commodity prices.
- Inverted Market - The term “inverted market” is used when current contract prices are higher than the far-end contract. An example of an inverted market would be corn futures during after a news release of a possible corn shortage; in this case, there may be a spike in corn prices and corn futures prices due to current high demand as traders anticipated the upcoming shortage of supply.
Additional considerations for trading far-end contracts:
There may be considerably fewer buyers and sellers when trading a far-end contract month. This means that if you were to place a market order to buy a contract, you can experience a significant amount of slippage if there is low liquidity in that market. It follows that if you are holding an open position (long or short) and wish to close your position, there is always the danger in an illiquid market that you may not be able to find a buyer or seller to liquidate your position at a favorable price.
As we have now discussed, there is typically more volume for the front-end contract month of a given commodity when compared to the far-end contract months (of course, this is NOT always the case).
As a reminder, the prices for each contract month will be different, so volume/liquidity is only one of many factors to consider when making trading decisions.