What Are Back Months?
Back months are the available futures contracts that have expirations or delivery dates in the furthest month into the future. These are also referred to as deferred futures or forward months.
- Futures contracts are issued by month throughout the year.
- Back months are futures contracts with expiration or delivery dates furthest into the future.
- The futures contract to expire next in line is known as the front month. Back months are the futures contracts that expire furthest from the front month.
- The prices of front month contracts are more accurate than back month contracts as back month contracts still have time to fluctuate depending on market conditions.
- As back month contracts have more price fluctuation, they are considered riskier and less liquid than front month contracts.
- Traders often take advantage of front months and back months by utilizing calendar spreads, which are established by simultaneously entering a long and short position on the same underlying asset at the same strike price but with different delivery months.
Understanding Back Months
Futures contracts are issued by month, also known as their delivery month, as that is when the underlying asset is to be delivered to the purchaser of the contract. For example, you will have a corn futures contract for March, May, July, September, and December.
In this example, the front month would be March and the back month would be December. Back months are futures contracts that expire in the furthest month than the front month, which is the next futures contract to expire. Though a back month refers to the futures contract furthest away from the front month, as time passes, a back month contract eventually becomes a front month contract.
A futures contract is a legal agreement to buy or sell a particular commodity or financial instrument at a predetermined price and time in the future. This differs from an options contract, which includes the option, but not the obligation, to buy or sell an asset at a specified time. Futures contracts are always obligatory and require delivery of the underlying commodity. Most traders, however, trade out of the futures contract before it expires and, therefore, delivery is not required.
For an example of engaging in a back month contract, let’s say you would like to buy wheat futures. It is April 15, and the next wheat futures contracts expire on May 30. You anticipate the price of wheat to increase in June, so instead of buying the front month contract of May, you buy a contract as far out as possible, in this case, November, with the idea that the price will come down. This November contract is a back month contract, and you are obligated to purchase the wheat futures at that time unless you sell out of the futures contract.
Front Months vs. Back Months
Back months may include an identical settlement price as that of the front month expiring in the near term; however, because the back month contract has a longer time to expiration, it will likely trade at a different price because the price has more time to be affected by market movements.
The ability to sell a futures contract at or near its value increases as it gets closer to its expiration date. In general, analysts believe that the prices of front month contracts are more accurate because the time of delivery for back months is further in the future, and therefore the prices of back month contracts vary.
Back month contracts may give some indication of what will happen in the markets in the future; however, they are also known to be riskier. Back month contracts are less liquid, and liquidity corresponds to risk. Due to this risk, back month contract premiums are typically more expensive than front month contract premiums.
Analysts typically compare the prices between a front month contract and a back month contract of the same asset to calculate what’s called a calendar spread, which is established by simultaneously entering a long and short position on the same underlying asset at the same strike price but with different delivery months. The goal of a calendar spread is to profit from time and volatility.