Deferred futures contract

What Is a Deferred Futures Contract?

A deferred futures contract refers to a futures contract with an expiration date furthest away from the current date. Within the broader field of derivatives, futures contracts are standardized agreements to buy or sell an asset at a predetermined price on a specified future date. When looking at a series of futures contracts for the same underlying commodity or financial instrument, the deferred futures contract is the one with the longest maturity. Traders and analysts often refer to these as "back-month" contracts, in contrast to "front-month" or "near" contracts, which have the closest expiration.

History and Origin

The concept of futures trading emerged from the need for producers and consumers to manage price risk for agricultural products. Early forms of futures contracts, known as "to-arrive" contracts, were traded in the mid-19th century. The Chicago Board of Trade (CBOT), established in 1848, was instrumental in standardizing these agreements, leading to the creation of the first formal futures contracts in 1864. This standardization, which included specified delivery months, naturally gave rise to the distinction between near and deferred contracts. The ability to trade contracts with varying maturities allowed market participants to plan further into the future, enabling long-term hedging strategies and providing continuous price discovery across a time horizon.

Key Takeaways

• A deferred futures contract is a futures agreement with an expiration date furthest into the future.
• It is used by market participants for long-term price discovery, hedging against future price movements, and speculation on distant market conditions.
• The pricing of a deferred futures contract often reflects market expectations for supply, demand, storage costs, and interest rates over an extended period.
• Understanding the relationship between deferred and near contracts is crucial for analyzing market structures like contango and backwardation.

Interpreting the Deferred Futures Contract

The price of a deferred futures contract provides insight into long-term market sentiment and expectations regarding the underlying asset. Unlike a spot price, which reflects immediate delivery, the price of a deferred futures contract incorporates factors such as the cost of carrying the asset until the delivery date (e.g., storage, insurance, financing costs for commodities) and anticipated supply and demand imbalances further out in time.

For instance, in commodity markets, if the deferred futures contract price is significantly higher than the near-month contract, it can indicate expectations of future scarcity or increased demand. Conversely, a lower deferred price might suggest an anticipated oversupply or declining demand. These price relationships are essential for understanding the overall market structure and are often analyzed in conjunction with the open interest data, which represents the total number of outstanding contracts not yet closed or delivered.

Hypothetical Example

Consider an oil producer planning output for next year. Today, in July 2025, the spot price for crude oil is $80 per barrel. The September 2025 futures contract is trading at $81, and the December 2026 futures contract (a deferred futures contract) is trading at $85.

The producer wants to lock in a price for a portion of their projected output in late 2026. By selling December 2026 crude oil futures contracts at $85 per barrel, the producer effectively hedges against a potential decline in oil prices over the next year and a half. This allows them to secure a predictable revenue stream for that future production, even if oil prices were to fall significantly by December 2026. The difference between the current spot price and the deferred futures contract price ($85 - $80 = $5) accounts for the market's expectation of future supply-demand dynamics and the cost of carrying oil over that extended period.

Practical Applications

Deferred futures contracts are widely used across various financial markets for purposes ranging from risk management to portfolio strategy.

• Corporate Hedging: Companies that rely on specific raw materials, such as airlines needing jet fuel or food manufacturers needing grains, can use deferred futures contracts to lock in future costs. This helps stabilize their operational expenses and manage commodity price volatility, providing greater certainty in financial planning.
• Investment and Speculation: Traders and investors engage with deferred futures contracts for speculation, betting on long-term price trends without necessarily intending to take physical delivery of the underlying asset. This allows them to gain exposure to future market movements.
• Arbitrage Opportunities: Professional traders often look for arbitrage opportunities between different futures maturities or between futures and the underlying spot market, capitalizing on temporary price discrepancies. The ability to trade a full curve of deferred contracts is critical for these strategies.
• Inflation Expectations: In financial futures, such as those tied to interest rates or inflation, the pricing of deferred contracts can provide insights into market expectations for future economic conditions and monetary policy.
• Regulatory Oversight: The existence and trading of deferred futures contracts are closely monitored by regulatory bodies. For instance, the Commodity Futures Trading Commission (CFTC) publishes the Commitments of Traders report weekly, which breaks down positions held by different market participants across various maturities, including deferred contracts, to provide market transparency.³ The Federal Reserve also notes the importance of derivatives for risk management and plays a role in their oversight.²

Limitations and Criticisms

While deferred futures contracts offer significant benefits, they also come with limitations and potential drawbacks.

One primary concern is the inherent uncertainty associated with long-term price predictions. The further out the expiration date, the more variables can influence the underlying asset's price, making accurate forecasting challenging. This can lead to increased risk for speculators if their long-term market view proves incorrect.

Furthermore, deferred futures contracts can be less liquid than near-month contracts. Lower liquidity can result in wider bid-ask spreads and difficulty executing large orders without impacting the market price. This reduced liquidity can also make it harder for traders to exit positions efficiently.

Another consideration is the impact of unexpected market events. While futures are designed to manage risk, unforeseen geopolitical events, natural disasters, or sudden policy changes can dramatically shift long-term price expectations, leading to significant losses for participants, particularly those with leveraged positions in a margin account. The financial crisis of 2008 highlighted systemic risks associated with complex derivatives, underscoring the need for robust regulatory frameworks and risk management practices, even if deferred futures are generally exchange-traded.¹

Finally, the phenomenon of roll yield can be a factor. When a deferred futures contract is in contango (higher price than the near contract), holding a long position and continually rolling it over as it approaches expiration can result in negative returns, as one sells the expiring contract at a lower price and buys the next deferred contract at a higher price.

Deferred Futures Contract vs. Near Futures Contract

The key distinction between a deferred futures contract and a near futures contract lies in their time to expiration. A deferred futures contract has a maturity date far in the future (e.g., several months or even years away), while a near futures contract (also known as a front-month or spot futures contract) has the closest upcoming expiration date.

Traders often use both types of contracts in combination, for instance, by implementing a futures spread strategy that involves simultaneously buying a deferred futures contract and selling a near futures contract (or vice-versa) to profit from changes in the price difference between the two. The relative pricing between these contracts provides valuable information about market conditions, such as the presence of contango or backwardation.

FAQs

What is the primary purpose of a deferred futures contract?

The primary purpose of a deferred futures contract is to allow market participants to manage price risk or speculate on prices far into the future. It provides a way to lock in a price for an asset that will be delivered or settled many months or even years from now, offering long-term planning capabilities.

How does the price of a deferred futures contract relate to the spot price?

The price of a deferred futures contract is generally influenced by the current spot price but also includes the "cost of carry." This cost encompasses expenses like storage, insurance, and financing until the future delivery date. Depending on market conditions, the deferred price can be higher (contango) or lower (backwardation) than the spot price.

Are deferred futures contracts less liquid?

Generally, yes. Deferred futures contracts typically have lower liquidity compared to near-month futures contracts. Most trading volume and open interest tend to concentrate in the front-month contracts, as they represent the most immediate price exposure. This means that executing large trades in deferred contracts might be more challenging and could result in greater price impact.

Who uses deferred futures contracts?

A wide range of market participants use deferred futures contracts. Producers and consumers of commodities use them for long-term hedging to secure future revenues or costs. Investors and speculators use them to express long-term directional views on prices. Additionally, financial institutions and portfolio managers might use them for long-term asset allocation or to manage overall portfolio risk.