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Futures Term Structure
Term Structure - Definition
Term Structure of futures contracts refers to the price curve formed by the prices of futures contracts over various expiration months.
Term Structure - Introduction
Futures contracts are usually offered across multiple expiration months for each underlying asset. Futures contracts of different expiration months trade at a different price reflecting differing future price expectation of the underlying asset. These different prices come together to form what is known as a "Term Structure". The term structure of futures prices often reveals critical information about the supply and demand relationship of the underlying asset which can be critical for traders.
This tutorial shall explore deeper what futures term structure means, how it affects your futures trading and how it can be used to help you make better futures trading and spot trading decisions.
What Exactly is Futures Term Structure?
Futures term structure is the prices of futures contracts on a single underlying asset over all available expiration months. This is usually plotted down as a graph like the one you see below of S&P500 E-mini Futures on 16 May 2011:
How To Interpret Futures Term Structure?
Futures term structure curve can come in a variety of shapes. As futures prices are future expected prices of the underlying asset, the shape of the term structure curve tells investors the supply and demand characteristic of the underlying asset and serves as a good investment guide for investing in the underlying asset as well as for trading its futures contracts.
Futures term structure curve generally comes in two forms; Normal and Inverted.
Normal and Inverted Term Structure is also known as "Normal Market" and "Inverted Market" in futures trading.
Interpreting the Angle Of Term Structure Curve
What Causes Changes in Futures Term Structure?
Futures term structure change when futures prices change. Even though a term structure curve might steepen or smoothen due to changes in short term supply or demand, the overall term structure in terms of normal or inverted market would not tend to change unless there is a drastic change in the supply or demand fundamentals for the asset. Basically, futures term structures change due to changes in price outlook of the underlying asset and such changes in price outlook are a direct result of trading by futures traders themselves, reflecting a fair price for the underlying asset after all possibilities of arbitrage has been digested away by arbitrageurs.