The Structure of Futures Markets

The whole unit turns on one question: which delivery months are priced higher, and why.

Which One-Liners Win Points?

• A normal market: distant (deferred) months trade higher than nearby months, an upward-sloping curve. Also called a carrying-charge market, a premium market, or contango.
• An inverted market: nearby (near-term) months trade higher than distant months, a downward-sloping curve. Also called a discount market, backwardation, or inverse carrying charges.
• The cash (spot) price sits below futures in a normal market and above futures in an inverted market.

What Drives a Normal Market?

• Carrying charges (cost of carry): storage, insurance, and financing (interest), the cost of holding the physical commodity over time. Whoever holds it for later delivery pays these costs, so distant months cost more.
• A full carry (full charge) market is one where the price difference between two months exactly equals the full cost of carrying the commodity between them.
• The premium of a distant month cannot exceed full carry; arbitrage (buying the physical, storing it, selling the overpriced distant contract) caps it there.
• Full carry is a ceiling, not a floor. The spread can sit at a partial carry with nothing forcing it higher.

What Drives an Inverted Market?

• The classic driver is a near-term supply shortage: the commodity is scarce or in strong demand for immediate delivery, so buyers bid up nearby months to secure product today.
• Carrying charges do NOT explain an inverted market; the structure runs opposite to carry, paying more for immediate delivery than for later delivery.
• Other causes: urgent immediate demand outpacing near-term supply, expectations that supply will loosen later, or a benefit to holding the physical now rather than later.

Which Gotchas Trip Students Up?

• "Normal" is not a mood word. It does not mean prices are stable; it is a technical label for one specific shape, deferred months priced above nearby months.
• Normal, carrying-charge, premium, and contango are interchangeable, and so are inverted, discount, and backwardation. Treating any of them as a different structure is wrong.
• Direction is the whole game. Deferred priced higher means normal; nearby priced higher means inverted. Miswiring the two is the most-tested trap in this unit.
• Carrying charges cannot cause an inverted market; storage, insurance, and financing only push deferred months up, which is the normal structure.

What Is the Memory Aid for Normal Versus Inverted?

Normal = Nearby is cheaper, so the price ladder climbs as you go out, deferred on top. Inverted flips it: the Immediate month sits on top and the ladder falls as you go out. Higher month tells you the structure: deferred high equals normal, nearby high equals inverted.

One-Breath Recap

A normal market is the default structure for a storable commodity: distant delivery months trade higher than nearby months because carrying charges (storage, insurance, and financing) pile up the longer the commodity is held, and the premium of a distant month cannot exceed full carry, a ceiling enforced by arbitrage rather than a floor; the cash price sits below futures. An inverted market reverses the whole pattern: nearby months trade higher than distant months because of a near-term supply shortage or urgent demand for immediate delivery, not carrying charges, and the cash price sits above futures. Normal, carrying-charge, premium, and contango name the same upward slope; inverted, discount, and backwardation name the same downward slope, and confusing the two directions is the single most-tested trap in the unit.

Need more than the recap? Read the full The Structure of Futures Markets unit.