WHAT IS Back Months
Back months are the available futures contracts for a particular commodity that include expirations or delivery dates furthest into the future. These are also referred to as deferred futures or forward months.
BREAKING DOWN Back Months
Back months for a given commodity are any set of futures contracts that expire in a different month than the front month, which is the next futures contract to expire.
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. A back month refers to the future contract furthest away from the front month, however as time passes a back month contract eventually becomes a front month contract.
For example, let’s say you would like to buy wheat futures. It is April 15 and the next wheat future 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 contact as far out as possible, in this case November. This November contract is a back month contract.
Implications of 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.
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, however they are also known to be more risky. 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 commodity at the same strike price but with different delivery months.