Normal Markets

A normal market is the everyday, default price structure for a storable commodity, so this is the shape you should expect unless something disrupts it. Anchor the direction first, then the reason behind it.

What a Normal Market Looks Like

Start with the price pattern, because naming the structure comes down to reading it correctly.

• In a normal market, distant (deferred) delivery months trade at higher prices than nearby (near-term) delivery months.
• Each successive contract maturity is priced progressively higher than the one before it: the further out the delivery month, the higher the futures price.
• The cash (spot) price is the lowest point, and prices step up as you move out along the delivery calendar.
• A normal market goes by several interchangeable names on the exam: carrying-charge market, premium market, and (in financial-market language) contango. All four labels describe the same upward-sloping price structure.

Exam Tip: Gotchas

• "Normal" is not a mood word. It does not mean prices are stable or that nothing unusual is happening. It is a technical label for one specific shape: deferred months priced above nearby months.
• Normal, carrying-charge, premium, and contango are interchangeable. If an answer treats any of them as a different structure, it is wrong; they all name the same upward slope.

Carrying Charges Drive the Structure

The upward slope is not arbitrary; it comes directly from what it costs to hold the physical commodity over time.

• The reason distant months cost more is carrying charges (also called cost of carry): the total cost of owning and holding the physical commodity from now until the later delivery date.
• Carrying charges have three core components worth spelling out:
  • Storage: warehouse, silo, or tank space to physically hold the commodity.
  • Insurance: protecting the stored commodity against loss or damage.
  • Financing (interest): the interest cost of the money tied up in owning the commodity, or the interest given up on that capital.
  • (Plus minor incidental costs.)
• Whoever holds the physical commodity for later delivery has to pay all of these costs, so a later-delivery contract logically sells for more than a nearby one. The extra price compensates the holder for carrying the commodity that much longer.
• The nearer the delivery month, the fewer carrying charges remain to be paid, so nearby months are cheaper.

Think of it this way: picture paying rent on a storage locker for a barrel of oil. A buyer who wants that oil delivered in one month owes one month of rent, insurance, and interest. A buyer who wants delivery in six months owes six months of all three. The six-month price has to be higher to cover the extra carrying, and that gap is exactly what pushes deferred months above nearby ones.

Full Carry Markets

The carrying-charge logic also sets a hard limit on how wide the gap between two months can get.

• A full carry (or full charge) market is a normal market where the price difference between two delivery months exactly equals the full cost of carrying the commodity from the earlier month to the later month.
• Put another way, the premium of the distant month over the nearby month has grown just large enough to completely reimburse a holder for storage, insurance, and financing over that period.
• The premium of a distant month cannot exceed full carry. Arbitrage caps it: if the distant month ever traded at MORE than nearby-price-plus-full-carrying-charges, a trader could buy the nearby (or the physical), store it, and simultaneously sell the overpriced distant contract for a locked-in, riskless profit. That buying-and-selling pressure pushes the spread back down toward full carry.
• The premium can be LESS than full carry. No arbitrage forces the spread all the way up, so a normal market often trades at only a partial carry. Full carry is the ceiling on the spread, not a floor.

Think of it this way: full carry is a lid on the spread, not a target it has to hit. The market can sit anywhere from a small premium up to full carry, but the moment the distant month tries to poke above full carry, arbitrage traders slam the lid back down because the physical-plus-storage route is now cheaper than the futures.

Exam Tip: Gotchas

• The premium of a distant month cannot exceed full carry. The intermonth spread in a normal market is capped at (but need not reach) the full cost of carry. A distant month trading at a premium GREATER than full carrying charges describes an arbitrage opportunity that cannot persist.
• Full carry is a ceiling, not a floor. The spread can be less than full carry (a partial carry) with nothing forcing it higher; it just cannot be more.