Futures - Contracts, Basis and the Cost of Carry

By EC Assets Research Team, Derivatives Research · Published 15 June 2026

Futures — A futures contract is a standardised, exchange-traded agreement to buy or sell a defined quantity of an underlying asset at a specified future date and price. Futures are the deepest source of standardised price discovery in commodities, equity indices, government bonds, and currencies.

Definition

A futures contract is a legal commitment between two parties to exchange a defined quantity of an underlying asset on a specified delivery date at a price agreed today. The contract is standardised by the exchange - specifying lot size, delivery month, settlement mechanism, and tick size - and cleared centrally so each party faces the clearing house rather than the counterparty directly.

Futures differ from forwards on three operational dimensions:

The daily mark-to-market mechanism - where gains and losses settle in cash each evening - is the defining operational feature. It eliminates accumulated counterparty risk but creates path-dependent funding requirements: a position that ends profitable can still produce margin calls along the way.

What Futures Markets Exist

The four largest futures market segments by open interest are:

Agricultural futures (corn, wheat, soybeans), softs (coffee, sugar, cocoa), and emerging-market currency futures fill out the longer tail. Total global open interest exceeds 30 trillion USD notional.

The Cost of Carry

The forward price of an asset is anchored to the spot price by a no-arbitrage relationship called the cost of carry:

F = S × e^((r − q) × T)

Where F is the forward price, S is the spot, r is the risk-free rate, q is the income yield (dividends, coupons, storage benefits), and T is time to maturity. For physical commodities, storage cost replaces dividend yield, and a convenience yield captures the benefit of holding physical inventory.

The shape of the futures curve relative to spot is therefore a direct indicator of carry conditions:

For a long-only futures investor (an ETP holder, for example), contango produces a structural drag known as roll yield decay: every time the front-month contract expires and is replaced by the next-month contract, the investor sells low and buys higher.

Worked Example - Roll Yield

Consider a one-month WTI Crude future at 80.00 USD/barrel when spot is 78.00. An investor wanting continuous exposure must roll the position every month. Suppose the contract behind the front month trades at 80.50:

If spot stays at 78.00 throughout, the investor's economic return is zero but the position lost 0.30/79.20 ≈ 38 basis points to the roll. Repeated monthly in a persistently contangoed market, the annual drag from rolling alone exceeds 4%.

Basis and Convergence

The difference between the futures price and the spot price is called the basis. As expiration approaches, the basis converges to zero - at expiry, the futures price must equal spot for cash-settled contracts or arbitrage will eliminate the gap.

For cash-and-carry arbitrage in a non-perishable asset like gold, any persistent basis above the cost of carry is risk-free profit: buy spot, sell futures, deliver at expiry. This arbitrage anchors the futures price tightly to the no-arbitrage forward.

Why Futures Matter

For an institutional book, futures are the primary tool for three things:

1. Tactical exposure. Buying or shorting index futures is faster and cheaper than trading the underlying basket. A 100 million USD equity exposure costs roughly 10–25 bps via futures versus 5–15 bps in cash, with same-day execution.
2. Hedging. Futures are the most liquid way to neutralise specific exposures: an airline hedges fuel cost via WTI futures; a global allocator hedges currency exposure via EUR or JPY futures; a bond fund hedges duration via Treasury futures.
3. Pure leveraged speculation. CTAs (commodity trading advisors) and macro funds use futures across asset classes precisely because they offer regulated leverage, transparent pricing, and broad coverage.

The deep liquidity in major contracts also makes them an essential price-discovery mechanism: the WTI front-month future is widely accepted as the price of oil, even though the contract represents physical delivery in Cushing, Oklahoma.

Roll Yield Mechanics

A practical illustration of how roll yield drives futures returns. Consider crude oil futures in a contango market:

To maintain long crude exposure beyond January expiration, the investor sells the expiring January contract (at $80) and buys the February contract (at $80.50). Cost of roll: $0.50 per barrel.

If crude prices stay flat over the next month, the new front-month contract trades at $80 by expiration. The investor's roll cost of $0.50 has been realised. Over a year with monthly rolls, the cumulative cost can reach 5-10% of notional, even with flat spot prices.

This is why passive long-only oil futures positions (USO, etc.) have lost most of their value over multi-year periods despite oil prices being roughly flat. The structural roll yield drag is the dominant factor.

Backwardation as Opportunity

Active futures managers profit from differentiating between backwardated commodities (positive roll yield) and contangoed ones (negative). Selecting which commodities to be long vs short of based on curve shape is a substantial source of alpha for systematic CTA managers.

References

1. Hull, J. C. (2022). Options, Futures, and Other Derivatives (11th ed.). Pearson.
2. Kolb, R. W., & Overdahl, J. A. (2007). Futures, Options, and Swaps (5th ed.). Wiley.