What Are Back Months?
In the commodity futures markets, the term “back months” refers to the futures contracts whose delivery dates are relatively far in the future. By contrast, so-called front months are those closest to the present date.
- Back month futures contracts are those whose delivery date is among the latest available.
- They are the opposite of front month futures contracts.
- Back month contracts tend to be more expensive than front month contracts, because they incorporate additional risk premiums due to time and relative liquidity.
How Back Months Work
The commodity futures markets are a large and important part of the global financial system. Through them, users of commodities—such as manufacturers who rely on commodities to produce their products—can plan ahead by buying several months’ worth of materials ahead of time. Likewise, traders can use the commodity futures markets to speculate on commodity prices or to engage in risk hedging.
Depending on their specific needs, buyers might have a preference for contracts that are relatively close at hand or far in the future. The contracts that have delivery dates farthest into the future are known as the back month contracts for that commodity. These contracts are identical to the other months’ contracts with respect to the quantity and quality of the commodities that underlie them. However, their prices are often different, primarily because of the increased uncertainty associated with back month futures contracts.
Given the wide variety of factors that can affect commodity prices—including production delays, weather patterns, and even political risks—it makes sense that futures with delivery dates further into the future would generally be more expensive. This dynamic is further reinforced by the fact that back month contracts tend to have less trading volume than front month contracts. This relative illiquidity adds to their riskiness, and tends to add to their price. Of course, if market participants believe that the price of the commodity will decline over time, then back month contracts might be cheaper than front month contracts, in spite of these factors.
Real-World Example of Back Months
To illustrate, suppose that you are in the market to purchase 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.
In this scenario, the November contract would be considered a back month contract, and you would be obligated to take delivery of the wheat at that time unless you sell out of the futures contract beforehand.