Oil Futures Convergence, Carry Costs, and ETF Roll Exposure
Summary
The discussion addresses whether a deferred oil futures contract should fall toward spot when it becomes the front-month contract after a roll. Futures prices reflect more than the current spot price: financing and storage-related costs can raise futures values, while convenience yield can lower them. These components help explain contango, backwardation, and possible irregularities in the nearby curve.
The response says convergence occurs toward expiration, but does not imply that a deferred contract must abruptly reprice merely because another contract expires. The quoted futures price reflects market expectations and changing supply and demand, and an investor can lose even if spot rises when the futures price remains higher. Consequently, a roll-related price difference alone does not establish an arbitrage opportunity, especially for ordinary traders. The discussion offers a cost-of-carry framework but does not quantify ETF tracking, roll mechanics, transaction costs, or the particular market conditions in the example.
Key ideas
- Futures prices reflect financing, storage costs, and convenience yield as well as spot prices.
- The futures curve can be in contango or backwardation, and nearby contracts may show a convenience-yield hump.
- Price convergence is associated with contract expiry and need not happen as an abrupt roll-date move.
- A futures premium alone does not guarantee arbitrage or profit in an inverse ETF.
Tags
Full text
# Oil futures price convergence
# Oil futures price convergence
Looking at oil prices now(https://www.cmegroup.com/trading/energy/crude-oil/light-sweet-crude.html)
May Futures - $20
June Futures - $26
Spot - $20
With price convergence theory, may futures matches closely with spot. This makes sense.
However, May futures are rolling over soon(Apr 21). Once rolled over, June futures become the main futures contract in variety of oil ETFs(USO, etc)
Assuming a scenario where the above prices remain constant until rollover date:
- When this happens, does June futures start to decline to match closer with spot price?(June futures goes from 26 to 23, for example).
- If this above happens, does this happen quickly? Does this not create opportunity for arbitrage, where you can buy inverse ETFs to profit off of the convergence of June futures to spot oil?
Thanks!
## Answer by Andreas (score 2)
https://quant.stackexchange.com/a/53364
The price of the future also depends on the amount you need to spend to hold your position. This can come in the form of interest payments to fund your investment, forex fees as well as insurance and storage costs. This is typically known as cost of carry. Often times another factor comes into play, and we can observe a "hump" for the next 1-2 futures contracts, which is caused by the so called "convenience yield" (A premium which is related to the benefit of having access to the commodity when there is a possible scarcity). You can read more about this and the shape of the futures curve by looking up Contango and Backwardation.
$F = Se^{(r + s - c) t}$
r = risk free rate; s = storage (insurance etc.); c = convenience yield
This price difference does and should typically not create an opportunity for arbitrage, at least not for common traders. The prices will converge slowly until rollover date. Also if you were to buy the June 2020 future now at a price of 26, you would lose money, even if the spot price went from 20 to 25. So the price of 26 indicates that there currently is an agreement between market participants that by expiry of the June contract, the Spot price will be at 26. Changes in supply and demand will of course constantly change both, the spot and the future prices.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.