What are Back Months?
Back months are the
How Do Back Months Work?
For example, let’s assume that John Doe wants to buy orange juice back month contract, because of all the available contracts, it expires last.. It is January 15, and the next orange juice contracts expire on March 31. The other available orange juice contracts expire on June 30, September 30, and December 31. John thinks the price of orange juice will rise in October, so instead of buying the front month contract (the March contract), he buys a contract that expires as far out as possible -- in this case, December 31. This December contract is the
Why Do Back Months Matter?
A futures contract’s 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” because they are better indicators of supply and demand. note that as time passes, a back month contract eventually becomes a front month contract.
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 , 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.
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