Learning About Futures

[slumlord 10]

Would it be accurate of me to say that in a contango market in order to break even with a long futures position your view has to be at least as bullish as the cost of carry, as well as being right?

 

How do you avoid losing out on the roll if the spot price doesn't move your way?

[DugDug 10]

Hi, in answer to the first question - basically yes

the second question -How do you avoid losing out on the roll if the spot price doesn't move your way?

see the first answer.

 

Seriously though. This is only really relevant if you are a longer term trader, and have to roll. If you are day trading, dont let it confuse you too much.

Over the long run, it could be argued that the backwardation and contango cancel each other out. So long as you constantly stay long and roll.

The reality is that if you are a long term trader it depends.

Sometimes it works in your favour, othertimes its against....many longer term traders actually participate in longer dated contracts rather than the front month all the time, for this reason.

Have a look at the attached charts - the first is a continuous back adjusted contract for nat gas, the second is a continuous non adjusted contract. (There are many ways to adjust depending on days, rolls etc - dont get top caught up in that)

(the charts also end on different dates, but the point I am trying to put across is...)

The point is - if you had been shorting Nat Gas all the way down, the contango worked in your favour, by approximately 3.70, as every time you rolled, the contract fell as much as the spot + the contango amount.

If you had been going long, you lost that amount.

simples....(compare the merecat)

[slumlord 10]

I am drooling imagining selling futures into those charts...

 

I am now tempted to think that it is slightly more favourable to be short in contango markets and long in backwardation instruments. Should I let this idea colour my trading decisions, even a little bit?

[Kiwi 16]

Not unless your average trade is in that noise zone.

 

In which case ask yourself why the hell that should be so?

[DugDug 10]

I am now tempted to think that it is slightly more favourable to be short in contango markets and long in backwardation instruments. Should I let this idea colour my trading decisions, even a little bit?

 

NO.

 

You should be aware of it, but there are plenty of markets that are in contango and will trend up..... crude oil over the last year is the first example that comes to mind.

if you are short term trading it should not make much of a difference,, and I would not even let it confuse the matter for you. This is largely only relevant if you are having to roll and maintain a position, over the entire period of such a long term move. Make sure you understand how to price a future - why it is different to the spot, and how the spreads work over time and contract months.

(If you are really interested then google back adjusted and continuous contracts - esignal also has some info on their continuous contracts, and I had cut and paste some notes from somewhere in my files in the attachment. There is a lot of info regards the best worst way to do things....never a right way!.)

Back Tested Data Information essay.doc