What is a Back Month Contract?
Also called a far month contract, a back month contract is acontract that has an date that is the farthest beyond the next approaching (called the “front month contract).
How Does a Back Month Contract Work?
For example, let’s assume that John Doe wants to buy orange juice futures. It is May 15, and the next orange juice contracts expire on June 30. John thinks the price of orange juice will rise in September, so instead of buying the front month contract (the June contract), he buys a contract that expires as far out as possible -- in this case, December 31. This December contract is a back month contract.
Note that as time passes, a back month contract eventually becomes a front month contract.
Why Does a Back Month Contract Matter?
A liquidity increases as it gets closer to its date because more people want to trade contracts that are near expiration (there are a number of reasons for this, many of which have nothing to do with the demand for the underlying commodity). Nevertheless, in general, analysts believe that the prices of front month contracts are more “accurate” in that they are better indicators of supply and demand.contract’s
So although back month contracts can give some indication about what the markets think will happen in the more distant future, liquidity corresponds to risk, and therefore back month contracts, which are less liquid, are also riskier than front month contracts. Because of this risk, back month contract premiums are usually higher than front month contract premiums. Analysts typically look at the difference in price between a front month contract and a back month contract for the same commodity to calculate what’s called a calendar spread.
Personalized Financial Plans for an Uncertain Market
In today’s uncertain market, investors are looking for answers to help them grow and protect their savings. So we partnered with Vanguard Advisers -- one of the most trusted names in finance -- to offer you a financial plan built to withstand a variety of market and economic conditions. A Vanguard advisor will craft your customized plan and then manage your savings, giving you more confidence to help you meet your goals. Click here to get started.
Read This Next
Moving averages define the trend and provide support or...Read More →
The cost of tuition has skyrocketed in the last 30 years. According to Bloomberg, college tuition fees have jumped more than 13-fold since...Read More →
If you’ve never done it before, calculating a monthly loan payment using Excel can seem intimidating. The good news is that it's relatively easy to do. In fact, Excel has a function built...Read More →