What is a Deferred Month?
Deferred months contracts are a futures trading instrument that pushes the contract expiration date into the future and not in the front-month contract. In this blog, we are defining what deferred month is and using real-world examples to further your understanding.
In the futures contract market, a “deferred month” refers to a futures contract for which the expiration date is farther into the future as compared to the current or front-month contract. As we know, futures contracts are obligations that the seller acquires to sell, and the buyer acquires to buy a specified quantity of the underlying asset at a predetermined price and on a certain date. To cite an example of a deferred month, consider a futures contract that expires in April, May, and June. In this case, the one expiring in June will be considered the deferred futures contract. Let us explore this concept further in this blog.
Understanding deferred month
To understand a deferred month in the context of futures contracts, you need to understand the following:
- Front Month: For a futures contract, the front month denotes the delivery month that’s the nearest. This front-month contract has the earliest delivery date and is the one that is most actively traded at any given time. For example, if the current date of the contract is in April, and the actively traded futures contract has a May delivery date, the May contract is the front month.
- Deferred Month: In contrast to the front month, these are contracts for which the subsequent delivery months are farther into the future. These are often popularly referred to as “further out” or “back months” contracts by traders and investors. As in the previous example, the futures contract with delivery dates in June, July, and subsequent months is considered back or deferred months.
Elaborating with a real-world example
Consider an example of corn futures in the trading of agricultural futures in the commodities market.
Suppose we are in June, and the expiration date for the actively traded corn futures contract for delivery in the front month is near. If you are a trader who wants to maintain exposure to the corn’s price beyond the current month, you will need to enter a deferred month contract in this case, such as the August or September contract. The parameters for this scenario would include:
Front Month (June): If you are holding positions in this current active contract, you can choose to take physical delivery of the corn. Alternatively, you can choose to roll over the positions to a deferred month contract before the arrival of the expiration date.
Deferred Month (August or September): If you are interested in extending your exposure to the corn’s price, you can choose a deferred month contract such as in August or September. This way, traders can maintain their positions without having to take the physical delivery of the corn and defer it to future delivery months.
Now, let’s examine your positions:
June: If you are holding on to the June corn futures, it’s time to decide whether to close out your positions or roll over your positions to a deferred month.
August or September: If you choose to roll over, you may enter contracts for delivery in the later months, viz., August or September. This way, you can continue your exposure to the corn’s price without taking delivery.
As observed, a deferred month contract allows traders to extend their positions and seamlessly adapt to market conditions that are prone to changes beyond the current front-month contract. This example showcases how traders can manage exposure and risks in the commodities market. This is akin to a farmer who can use a deferred month contract to provide a hedge against potential price fluctuations by locking in the future selling price of their corn crop.
Factors affecting deferred month contract choice
So, when do you know to opt for a deferred month contract? Various factors dictate your choice of trading in either the front month or a deferred month. They include:
- Market conditions
- Trading strategies
- The specific needs of the trader or investor
Choosing the front-month contract has its own advantages. For example, both liquidity and trading volumes tend to be higher, which makes it a preferred choice for many traders and investors. Despite this, many traders may still prefer choosing deferred months due to specific reasons such as managing risks over a more extended period by taking a longer-term position.
If you want to dabble in futures trading, gaining a thorough understanding of front-month and deferred-month contracts is paramount. Often, this can leave an impact on trading costs, liquidity, and the overall execution of your trading strategies. To achieve this seamlessly, the first step is to be aware of the expiration dates of your different contracts. You must also be prepared to roll over positions if required, especially as the agreements approach expiration and you are about to transition from the front month to deferred months.
If you are still unsure about deferred months or how to maximise your gains with deferred month contract trading, consulting an experienced financial advisor will be the way to go. This will ensure you explore deferred months trading while safeguarding your investments.