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How can rolling future positions affect performance?

A future is a contract that allows someone to buy a fixed amount of a specific commodity at a set date in the future.

The price of a future often offers a good proxy to the spot price, but they do not always move in tandem. The futures price can differ from the spot price for a number of reasons, including interest rates, the cost of storing a commodity, and market expectations. For example, if oil has a spot price of $100 per barrel and it costs $2 per month to store and insure a barrel of oil, the futures price for delivery of a barrel of oil in a month's time may be $102.

The situation where the futures price is higher than the spot price is known as 'contango', and the opposite is known as 'backwardation'.

Contango in particular causes problems for ETPs which use futures contracts. Most futures contracts expire on a rolling monthly basis and, as it costs significantly more to store and insure a barrel of oil for a month than for a day, these costs fall as the end of the contract approaches and the price of the future moves towards the spot price.

In the example above, assuming the current, or 'spot', price remains at $100 per barrel, an ETC purchases a futures contract for one barrel of oil which expires in a month's time for $102. After a month, the ETC will need to 'roll-over' the futures contract - effectively selling the old future and buying a new one for a month's time. If the old future was not sold, the ETC would have to take delivery of the physical oil (which it has no need for). The futures contract purchased for $102 has reduced in price to $100 as it nears expiry. The cost of a new contract is $102, so the ETC has made a loss of $2 even though the spot price has remained constant.

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