Investing in future curves

Where would you store a gold nugget? Where would you put a barrel of oil? How would you manage a purchased amount of livestock? By taking a position in futures, you don't buy the actual underlying asset(s) but you do profit 1 to 1 from the price movement of the relevant underlying asset.

Futures are forward contracts. They are contractual agreements for a future delivery of a particular product. The moment at which the whole thing is to be settled is determined in the contract, as is the product the agreement relates to.

This can vary from a certain share, bond or commodity, for example, or any other financial product. Everything is noted in the contract, except the price; this is determined by the two opposing parties during the transaction on the exchange.

Restricted durations

Futures are contractual agreements that have a restricted duration. The moment the contract ends, they are no longer valid.

Settlement can take place by means of delivery of the underlying asset (physical delivery of shares, oil or grain, for example), but also by one cash settlement whereby the value difference is paid out in money.

Futures on financial assets are available with various durations. Some are valid for a month, others for a year. This means that not only the date of delivery is set at a different point in time, but that as a consequence of this they actually involve different products, possibly with totally different price developments.

Copper prices

And so it was in the case of the metal copper that the three-monthly forward dropped in price from $8,800 to $6,400 between May 2006 and December 2006.

During the same period, the five-yearly future rose from $2,500 to $4,800. That meant that the future curve changed from a strong downward trend to a more levelled line.

So bear in mind that we can't just talk about THE price of a financial product. There are several future prices (referring to different terms or maturities) available for traders. If we want to talk about the price of the physical material, we use the term spot price.