Forward-Price Bounds and the Asymmetry of Commodity Arbitrage

Summary

The note uses gold forward prices at two maturities to illustrate a carry-based arbitrage. If the later contract is priced above the earlier contract adjusted for financing and storage-related carry, a trader can buy the earlier exposure and sell the later one, financing the purchase and locking in the price difference at maturity. The example uses an interest-rate adjustment to show why the later price may be considered expensive.

The reverse trade is not automatically an arbitrage when the later contract is cheap. Selling the near contract requires access to the commodity for delivery, which may not be available; buying the later contract and selling the near one can instead be a directional position. The response emphasizes that storable commodities have an upper bound on contango from carrying costs, while backwardation has no equivalent simple upper bound. The example omits storage costs, convenience yield, contract details, and transaction costs, all of which affect practical pricing and arbitrage feasibility.

Key ideas

• Financing and carry provide a benchmark for comparing forward prices at different maturities.
• A sufficiently expensive later contract can be sold against an earlier purchase to lock in a spread, subject to implementation assumptions.
• The reverse position may require delivering a commodity the trader does not possess.
• For storable commodities, carrying costs constrain contango, while backwardation has no equivalent simple upper bound.
• A trade that profits only if the price relationship moves favorably is speculation rather than arbitrage.

Tags

# Taking advantage of mispricing in forwards


# Taking advantage of mispricing in forwards












Suppose gold futures are selling at 360 in February, and 370 in April. Interest is 9% annually. Note that 360*(1+0.09*2/12)=365.4, so the April futures is overpriced. Then we can sell April and buy February. We borrow 360 in February, hold the gold until April, and pay off the loan and deliver gold in April to get $4.6 in April for sure.

I am not sure what the analogous trade is if the April futures is underpriced - say April is 364. Then we should buy April and sell February. But we don't have gold to deliver in February.

Any help completing this last trade is greatly appreciated. Thanks in advance.

## Answer by Alex C (score 2, accepted)

https://quant.stackexchange.com/a/35586

You are right. There is a basic asymmetry there. Because of storage there is an upper limit to $F_{apr}-F_{feb}$ but no such upper limit to $F_{feb}-F_{apr}$. You can still express your opinion by buying april futures and selling feb, but it is not an arbitrage (you'll make money if you are right and lose if you are wrong).

Or as traders sometimes put it "for a storable commodity there is a limit to contango but not to backwardation".

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.