Adjusted futures price

What Is Adjusted Futures Price?

The adjusted futures price refers to a modified historical price series for futures contracts that accounts for discontinuities that occur when creating a continuous data stream. These discontinuities typically arise from rolling over from one expiring contract to the next active one, or from corporate actions affecting the underlying asset (like dividends or stock splits for equity index futures). This adjustment is crucial for accurate technical analysis, backtesting trading strategies, and calculating long-term returns within the derivatives market, which is a key component of financial markets data analysis.

History and Origin

The concept of adjusting futures prices for historical analysis evolved with the increasing sophistication of quantitative finance and the need for seamless, long-term price series. As futures contracts gained prominence as tools for hedging and speculation across various asset classes—from commodities to financial instruments—the challenge of analyzing their performance over extended periods became apparent. Unlike stocks, which generally offer a continuous price history, individual futures contracts have finite lifespans, expiring on a specific delivery date.

Early futures markets, dating back centuries, initially focused on physical delivery and were less concerned with long-term price series analysis. However, with the formalization of exchanges and the introduction of financially settled contracts, particularly in the 20th century, the demand for continuous price data grew. The development of modern derivatives exchanges like the Chicago Board of Trade (CBOT) and the Chicago Mercantile Exchange (CME) spurred innovations in data management. The broader economic history of futures markets highlights their evolution from simple agreements to complex financial instruments, necessitating advanced data methodologies to support sophisticated analysis. Data vendors and financial researchers developed methods to "stitch" together successive futures contracts, applying adjustments to mitigate the artificial price jumps that would otherwise appear when transitioning from one contract month to the next.

Key Takeaways

• Adjusted futures price creates a continuous historical data series by accounting for contract rollovers and corporate actions.
• This adjustment is vital for accurate backtesting of trading strategies, technical analysis, and long-term performance evaluation.
• Without adjustment, historical charts of individual futures contracts would show artificial price jumps at contract expiration and rollover points.
• Common adjustment methods include fixed-point adjustments (adding/subtracting the price gap) or ratio adjustments.
• Data providers typically offer adjusted futures price series, as these are not directly observed market prices.

Formula and Calculation

The adjusted futures price is typically calculated to create a continuous futures contract series, which eliminates the artificial price gaps that occur when transitioning from an expiring contract to the next active contract. One common method for this adjustment is the fixed-point adjustment.

The formula for a fixed-point adjusted futures price series is:

Where:

• ( P_{\text{adjusted}, t} ) = The adjusted futures price at time ( t )
• ( P_{\text{active}, t} ) = The price of the newly active contract at time ( t )
• ( P_{\text{expiring}, t_r} ) = The price of the expiring contract at the roll date (( t_r ))
• ( P_{\text{active}, t_r} ) = The price of the newly active contract at the roll date (( t_r ))

This formula essentially takes the price difference between the expiring and new active contract at the moment of the roll and applies this difference as a fixed offset to all historical prices of the new contract. This ensures that the new contract's historical price path aligns smoothly with the previous contract's path, preventing a sudden, artificial jump or drop in the continuous series. Other methods, such as ratio adjustments, also exist, which apply a multiplier instead of an additive offset. The specific methodology can vary among data providers, influencing how market participants analyze historical data.

Interpreting the Adjusted Futures Price

Interpreting the adjusted futures price involves understanding that it is a synthetic data series, not a price directly traded in the market at any given moment. Its primary purpose is to provide a clean, continuous historical record for analysis. When observing a chart of an adjusted futures price, traders and analysts can identify long-term trends, support and resistance levels, and other technical patterns without the distortions caused by contract rollovers.

For instance, if a commodity futures contract typically trades higher in further-out months (a state known as contango), a simple concatenation of contracts would show a series of upward jumps. Conversely, in backwardation, it would show downward jumps. The adjusted price smooths these out, allowing for a more accurate visual representation of the underlying commodity's price evolution over time. This continuous series is particularly valuable for developing and backtesting quantitative trading strategies and for performing long-term risk management analysis.

Hypothetical Example

Consider a hypothetical continuous crude oil futures contract. On September 15th, the active October contract is set to expire, and the November contract will become the new active contract.

• On September 14th, the October contract closes at $85.00.
• On September 15th (roll date), just before the roll, the October contract is trading at $84.50, and the November contract is trading at $86.00.

The price difference at the roll is ( $84.50 - $86.00 = -$1.50 ).

To create the adjusted historical series for the November contract using the fixed-point method, this -$1.50 adjustment is applied to all past prices of the November contract.

If the November contract's historical closing prices were:

• September 10th: $85.50
• September 11th: $85.80
• September 12th: $85.00
• September 13th: $84.70

The adjusted prices for these dates would become:

• September 10th: ( $85.50 + (-$1.50) = $84.00 )
• September 11th: ( $85.80 + (-$1.50) = $84.30 )
• September 12th: ( $85.00 + (-$1.50) = $83.50 )
• September 13th: ( $84.70 + (-$1.50) = $83.20 )

This process ensures that when the October contract's historical series transitions to the November contract's series, there is no artificial $1.50 jump downward in the price chart, allowing for a smoother and more meaningful historical analysis of the continuous futures contract.

Practical Applications

Adjusted futures prices are fundamental for a variety of analytical and practical applications in financial markets:

• Quantitative Analysis and Backtesting: Researchers and quantitative traders rely on continuous, adjusted price data to develop and test algorithmic trading strategies over long historical periods. Without adjustment, spurious price jumps would distort performance metrics and invalidate models.
• Performance Measurement: Investment funds and indices that track futures markets use adjusted prices to accurately calculate long-term returns and volatility. This ensures that their performance benchmarks reflect the true market movements, not artifacts of contract rollovers.
• Technical Analysis: Chartists and technical analysts use adjusted price charts to identify trends, support/resistance levels, and patterns that span multiple contract cycles. This allows for a more holistic view of market sentiment and price action for the underlying asset.
• Arbitrage Strategy Development: While direct arbitrage on adjusted prices isn't possible (as they're not spot prices), the analysis of historical relationships between different contract months, informed by adjusted series, can aid in developing strategies based on term structure changes.
• Risk Management: Financial institutions and large market participants use adjusted data to model long-term price exposures and assess value-at-risk for their futures contracts portfolios, contributing to robust risk management frameworks.
• Regulatory Oversight: Regulatory bodies like the Commodity Futures Trading Commission (CFTC) monitor futures markets for stability and fairness. While they focus on actual traded prices, the analysis of long-term trends, often using adjusted data, can inform their understanding of market dynamics and potential systemic risks.
• Market Research: Academics and industry analysts use adjusted futures data to study market efficiency, price discovery mechanisms, and the impact of various economic factors on commodities or financial futures over time. For example, during the March 2022 nickel trading disruption on the London Metal Exchange, analysis of how the price series adjusted (or didn't) was critical to understanding the market's response.

Limitations and Criticisms

While adjusted futures prices are indispensable for historical analysis, they come with certain limitations and are subject to criticisms:

• Notional Prices: The most significant criticism is that an adjusted futures price is a synthetic construct and does not represent a price at which a trade could have been executed in the past. It is a mathematical manipulation of actual traded prices designed to create continuity. This means it cannot be used for direct trade execution simulation or verification of specific trade fills.
• Methodology Dependence: Different data providers may employ varying adjustment methodologies (e.g., fixed-point, ratio, or combination methods), leading to slightly different adjusted price series for the same contract. This can cause discrepancies in analytical results if not accounted for. Users must understand how futures contracts are structured and priced and how adjustments are applied by their data source.
• Impact on Volatility: The adjustment process can subtly influence volatility calculations, especially if large price gaps are "smoothed" away. While this creates a visually cleaner series, it might not perfectly reflect the true intraday or day-to-day volatility experienced by traders holding specific contracts through rollovers.
• Complexity with Corporate Actions: For equity index futures, adjustments for dividends, stock splits, or other corporate actions on the underlying components can add further layers of complexity, requiring careful consideration of the adjustment impact on the price series.
• Basis Risk: The difference between the spot price of an underlying asset and the futures price (known as basis) is a real market phenomenon. Adjusted futures prices smooth out rollover gaps, which are a component of basis, potentially obscuring certain aspects of arbitrage or hedging analysis if one is strictly focused on the raw basis dynamics.

Despite these limitations, the utility of adjusted futures prices for long-term historical analysis outweighs their drawbacks for most quantitative and technical applications, provided users are aware of their notional nature.

Adjusted Futures Price vs. Settlement Price

The adjusted futures price and the settlement price are both critical concepts in futures markets, but they serve entirely different purposes and represent different values.

In essence, the settlement price is the daily snapshot of a futures contract's value, dictating the financial obligations between traders. The adjusted futures price, on the other hand, is a tool for researchers and analysts to stitch these daily snapshots into a coherent, long-term narrative for analytical purposes.

FAQs

Q1: Why do futures prices need to be adjusted?

Futures prices need to be adjusted primarily because individual futures contracts have a finite lifespan and expire. To create a long, continuous historical price chart for analysis or backtesting, data providers "roll over" from one expiring contract to the next active one. This rollover often creates a price gap due to differences in interest rates, storage costs, convenience yield, or market sentiment between contract months. Adjusting these prices smooths out these artificial jumps, making the historical series more useful for trend analysis and quantitative models.

Q2: Is the adjusted futures price a real market price?

No, the adjusted futures price is not a real market price that you would see quoted on an exchange or execute a trade at. It is a synthetic data series created by data vendors to provide a continuous historical record. The actual prices traded in the market are the raw prices of individual futures contracts, which are then used to calculate daily settlement prices.

Q3: Who uses adjusted futures prices?

Adjusted futures prices are primarily used by quantitative analysts, financial researchers, algorithmic traders, and anyone performing historical analysis or backtesting of trading strategies on futures markets. They are essential for understanding long-term trends and performance across different contract cycles without distortion.