What Is Far Month?
The "far month" refers to a futures contract with a distant expiration date in the future. In the context of futures and derivatives markets, futures contracts are typically listed for several consecutive months, extending out for varying periods, sometimes several years, depending on the underlying commodity or financial instrument. The far month contracts are those furthest out in this series of listed expiration dates, contrasting with "near month" or "front month" contracts which are for the nearest upcoming expiration. Traders and investors utilize far month contracts for various trading strategies, often related to long-term price outlooks or extended hedging needs.
History and Origin
The concept of standardized forward agreements, which evolved into modern futures contracts, emerged to manage agricultural price risks. The Chicago Board of Trade (CBOT), established in 1848, was instrumental in this development, listing the first standardized "exchange-traded" forward contracts, known as futures contracts, in 1864.7 This innovation provided a centralized and more efficient venue for buyers and sellers to negotiate future transactions. Early futures contracts were primarily for agricultural products like wheat and corn. As these markets matured, and contracts began to be listed for multiple delivery periods, the distinction between near-term and long-term contracts naturally arose, leading to terms like "far month" to differentiate contracts with more distant delivery obligations. The Commodity Futures Trading Commission (CFTC), an independent U.S. government agency, was later established in 1974 to regulate the U.S. derivatives markets, including futures, ensuring market integrity and protecting participants.6
Key Takeaways
- A far month contract is a futures contract with a distant expiration or delivery date.
- It is one of a series of listed futures contracts for a particular underlying asset, traded on an exchange.
- Far month contracts are often less liquid than near month contracts due to the longer time horizon.
- They are typically used by market participants for long-term speculation, hedging against future price movements, or reflecting long-term supply and demand expectations.
- The prices of far month contracts are significantly influenced by factors like storage costs, interest rates, and expected future supply and demand, rather than immediate market conditions.
Interpreting the Far Month
Interpreting the far month price involves understanding its relationship to the current spot price and other contract months. The price of a far month contract often reflects the market's long-term expectations for the underlying asset. For commodities, a higher far month price compared to the near month price (a condition known as contango) can indicate expectations of future scarcity, increased demand, or simply the cost of carry, which includes storage and financing costs. Conversely, a lower far month price (backwardation) might suggest an expected increase in supply or a decrease in demand in the future, or perhaps a premium for immediate availability. These price relationships are crucial for participants engaging in arbitrage or various risk management strategies.
Hypothetical Example
Imagine it's July, and a crude oil producer wants to lock in a price for oil they expect to extract and sell next year. They look at the futures market on the CME Group. The July contract is the near month, the August contract is the next, and so on. The far month contracts could be for delivery in June of next year, or even further out.
Let's say the current spot price of crude oil is \($75/\text{barrel}\).
- The August (near month) futures contract might trade at \($75.50/\text{barrel}\).
- The December (mid-term) futures contract might trade at \($78.00/\text{barrel}\).
- The June of next year (far month) futures contract might trade at \($80.50/\text{barrel}\).
The oil producer might choose to sell the June next year far month contract at \($80.50/\text{barrel}\). By doing so, they are hedging against a potential drop in oil prices by June next year. This locked-in price for the far month contract provides them with certainty for their future revenue, even if the spot price of oil falls significantly by that time. This decision reflects their long-term outlook and their use of the futures market for price stability.
Practical Applications
Far month contracts serve several practical purposes in futures markets:
- Long-Term Hedging: Companies that have long-term supply or demand obligations use far month contracts to lock in prices or costs far in advance. For example, an airline might buy far month jet fuel futures to hedge against rising fuel costs for flights scheduled a year or more away.
- Strategic Planning: Businesses and investors use the prices of far month contracts as indicators of long-term market sentiment and expectations for supply and demand. This information aids in strategic business planning and capital allocation decisions.
- Investment and Speculation: Traders with a long-term directional view on an asset's price may take positions in far month contracts, expecting to profit from significant price movements over an extended period. This differs from short-term speculation in near month contracts.
- Analysis of Market Structure: The relationship between far month and near month prices (the "futures curve") provides insights into market conditions like contango or backwardation, reflecting current and anticipated imbalances in supply and demand. Detailed contract specifications for various futures, including their delivery months, are published by exchanges like CME Group.4, 5
Limitations and Criticisms
While useful, far month contracts have limitations. One significant criticism is that their prices may not always be accurate predictors of future spot prices. Futures prices are influenced by the cost of carry, storage costs, and the need for immediate delivery, in addition to pure price expectations. Academic research often highlights that while futures prices offer insights, they may not perfectly forecast future spot prices due to factors like risk premia and market frictions.2, 3
Furthermore, far month contracts typically have lower liquidity compared to near month contracts. This means wider bid-ask spreads and potentially larger price impacts for significant trades, making them less suitable for active short-term trading. Market efficiency in far month contracts can also be debated, as fewer participants and less frequent trading might lead to less precise price discovery compared to highly liquid front-month contracts.1 Investors must also consider the increased time to expiration, which amplifies the impact of changes in interest rates and volatility on the contract's value.
Far Month vs. Near Month
The primary distinction between a "far month" and a "near month" (or "front month") futures contract lies in their respective delivery or expiration dates.
| Feature | Far Month | Near Month (Front Month) |
|---|---|---|
| Delivery Date | Distant future (e.g., several months to years) | Nearest upcoming month |
| Liquidity | Generally lower | Generally higher |
| Price Drivers | Long-term supply/demand expectations, cost of carry, interest rates | Immediate supply/demand, current market conditions |
| Use Cases | Long-term hedging, strategic planning, long-term speculation | Short-term hedging, active trading, immediate price discovery |
| Market View | Reflects long-term outlook and expectations | Reflects immediate market sentiment and conditions |
Confusion can arise because the terms are relative. What constitutes a "far month" for one commodity (e.g., a highly perishable good) might be different from another (e.g., a financial index). However, the core concept remains: the far month contract is the one furthest from the current date among those actively traded, while the near month is the closest.
FAQs
What is the significance of a far month contract?
The significance of a far month contract lies in its ability to provide a price reference for an asset's value far into the future. It allows market participants to hedge long-term risks or express a long-term speculative view, which is essential for certain business operations and investment strategies.
How does the price of a far month contract differ from a near month contract?
The price difference between a far month and a near month contract reflects the "cost of carry" (storage, insurance, financing costs) for physical commodities, or the time value and interest rate differentials for financial futures. It also incorporates the market's expectations about future supply and demand dynamics over the longer period, impacting the price discovery process.
Are far month contracts less liquid?
Yes, generally, far month contracts tend to be less liquid than near month contracts. This is because most trading activity and open interest are concentrated in the nearby expiration months, where immediate hedging and speculative needs are most pronounced. Lower liquidity can mean wider bid-ask spreads and potentially more volatile price movements.
Why would someone trade a far month contract instead of a near month?
A trader or investor might choose a far month contract for several reasons: to implement a long-term hedging strategy, to express a directional view on a commodity or financial instrument that they anticipate will materialize over an extended period, or as part of a spread trade that aims to profit from the price differential between different contract months.