The Curve

by s7ven

The Contract · Futures

The curve

What happens when you plot every delivery month at once, and why the shape has consequences for anyone holding a position past expiry.

4 terms

Basis converging toward expiry Two lines, one for the futures price and one for the spot price, starting apart on the left and meeting at the right hand edge marked expiry. The shrinking gap between them is labelled basis. EXPIRY FUTURES SPOT BASIS TIME →
Whatever the curve looks like today, this convergence is not optional. At delivery the contract is the underlying, so the gap has to close. What is uncertain is the path, and which of the two lines does most of the moving to get there.
Basis

The difference between the spot price of an underlying and the price of a futures contract on it.

Basis converges toward zero as expiry approaches, because at delivery the contract simply is the underlying.

See also contango and backwardation
Rolloverthe roll

Closing an expiring contract and opening the equivalent position in a later delivery month, to maintain exposure past expiry.

Whether the roll costs or earns depends on the shape of the curve. Repeated across many rolls, that difference is what causes futures-based products to drift away from the spot price they appear to track.

See also contango and backwardation
Contango and backwardation

Descriptions of forward curve shape: upward sloping and downward sloping respectively.

Both words come from the nineteenth-century London Stock Exchange, where they described settlement deferral fees rather than commodity curves.

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Open interest

The number of contracts currently outstanding and not yet closed or delivered.

Distinct from volume, which counts activity. Volume can be enormous on a day when open interest does not change at all, if participants are opening and closing rather than accumulating.