Why Futures Premium Decay Does Not Create Free Expected Profit

Summary

The discussion addresses whether shorting a futures contract earns a return simply because its price converges toward spot as expiration approaches. It explains that the futures price difference reflects carrying costs and financing, rather than a separate premium that a short can collect without offsetting economics. In an illustrative equity-index example, a short position gains if the index level stays unchanged while the futures price converges, but this is framed as compensation for effectively lending funds at the risk-free rate.

For physical commodities such as oil, storage and related costs also shape the futures price. The answer therefore argues that, on average, convergence alone does not produce excess profit: the apparent gain corresponds to financing or other costs borne by the futures buyer. This is a conceptual explanation, not a trading test. It assumes the stated flat-spot scenario and does not quantify changing carry inputs, risk premia, transaction costs, margin effects, or outcomes under spot-price moves.

Key ideas

• Futures prices reflect financing and, for physical goods, costs such as storage and insurance.
• Convergence toward spot can create a gain for a short if spot remains unchanged.
• That convergence gain is interpreted as compensation for financing or carrying costs, not a free premium.
• The explanation does not establish returns when spot prices move or when carry inputs change.

Tags

# Is it possible to make money from futures premium decay?


# Is it possible to make money from futures premium decay?












A futures premium decays as expiration nears (eg contango). Say I short West Texas Intermediate (WTI) crude oil futures. If the spot price has even odds of going up or down, do I (on average) profit through premium decay? Or is that not counted if you're shorting?

## Answer by MonteCarloSims (score 0, accepted)

https://quant.stackexchange.com/a/50027

As Drew mentioned in the comments above, "there is no premium in futures." The higher forward price is representative of things like cost of capital, insurance, storage, etc.

The most pure example I can think of would be on S&P futures (due to high liquidity and lack of insurance/storage considerations):

```
Spot - $3140
1 mo future - $3144.25

You sell the futures contract and wait 1 month with no movement in the S&P. 
You will have made $4.25 (times the contract multiplier, removed here for simplicity.)
```

However, the way to look at this is that the buyer of the contract essentially 'borrowed' money from you at the risk free rate of ~1.62%.

Now extrapolate that concept to oil where there are extra costs associated with the physical good that you would essentially be lending the purchaser of the contract funds for. (Since they are not paying for it now, but some time in the future thanks to your contract.)

So, in short, on average you come out exactly even.

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.