Both futures and forwards represent an investment for the future delivery of metal. One of the main structural differences between futures and forwards is the form of
the expiry dates that are made available. Futures are made available in contract months. There is usually one month that is more actively traded at any point in time, and this will typically remain the active month for two or three months at a time. Whilst delivery of metal is the bedrock of both futures and forwards, it is more common for positions to be closed out ahead of delivery, or rolled forward to a further dated contract. Market liquidity is therefore important to
an investor both when the position is opened and when it is closed out. This liquidity manifests itself in the bid-offer spread which paid by the investor. In the case of futures, where a position is opened in the active contract month, which has the most liquidity, when this is closed out say a
month later, this contract month is still likely to be the most active contract month, and therefore offering high levels of liquidity for the closing transaction.
To put some numbers on this, let’s take as an example a transaction for $1 million investment exposure in copper futures at COMEX. With the contract price at 306.40 cents per pound, and a contract size of 25,000 pounds, this implies a purchase of 13 futures lots. The typical bid-offer spread on the active month futures contract is 1 tick, or 0.05 cents per pound, which equates to $12.50 per lot. Assuming that position is still in the active month when it is closed, the investor would face the same bid-offer spread. Therefore for the trade as a whole, the cost of the bid-offer spread can be calculated as $162.50 for the $1 million exposure.
The bid-offer spread for futures months other than the active month is typically two ticks, or 0.10 cents per pound. If, by the time the position was closed, the position was no longer in the active month, the investor would face a wider bid-offer spread on the closure. In this case, the cost of the bid-offer spread for the trade would be the average of 0.05 and 0.10, ie 0.075 cents per pound, or $243.75 in total.
Exchange fees are another cost of trading that can be examined, although these are relatively small when compared to other costs such as the bid-offer spread, brokerage charges etc. For futures trading, the fee structure is very straight forward. The non-member transaction fee for a screen based transaction is $1.50 per lot, for both opening and closing the position. For the $1 million trade as a whole, this is therefore $39. The combined cost from bid-offer spread and exchange fees is therefore $201.50 for this transaction when executed as futures.
|Opening Trade||bid||offer||spread||fee per lot|
|Buy||13 lots||Jul-18 Copper||316.8||316.85||0.05||1.5|
|Sell||13 lots||Jul-18 Copper||308.15||308.2||0.05||1.5|
|Spread Cost||Average spread x Number Lots x Lot Size|
|= ((0.0005+0.0005)/2) x 13 x 25,000|
|Fee Cost||Fee per lot x Number Lots|
|= (1.50 x 13) + (1.50 x 13)|
Source: Bloomberg LP. See Footnote 1
In contrast to futures, forwards markets are made available with daily contracts. The greatest liquidity is available in the date that is three months forward from the trade date. This provides a convenient entry point for opening a position, but once the position is held for more than a day, the market liquidity shifts to next three-month date, and liquidity for the date of the open position is considerably worse.
There are trading strategies that are used to manage this liquidity risk. Expiry dates (often referred to as prompt dates) on the third Wednesday of the month are quoted further out, and these provide a slightly better location to hold open interest. The bid-offer liquidity in these dates is still poor compared to the three-month date, but better than a completely off-cycle value date. As examples of bid-offer spreads quoted on screen, the active three-month date for copper will typically see a spread of $1.50 per metric ton,
whereas the bid-offer spread for third Wednesday dates when quoted outright is typically $8 per metric ton, and the bid- offer spread for an off-cycle date can be far wider, and usually not available to trade on screen. Spreads are tighter for the carry trades between three-month and third Wednesday dates, where spreads are typically $0.50 per metric ton2.
Replicating the $1 million trade example above using forwards where the contract price is $6790 per metric ton, and the contract size is 25 metric tons, requires a transaction size of 6 lots. Using the strategy of taking exposure at the three-month date and then moving to a third Wednesday date requires two separate transactions. Closing out the transaction also involves a carry transaction to move the exposure back to the prevailing three-month date, and then finally closing out the trade at the three-month date. In this scenario, the bid- offer spread that is paid on this whole transaction is the sum of the spread seen at the three-month date and the spread in the carry, which is a combined amount of $2.00 per metric ton.
For the $1 million transaction in the example, this equates to a cost $300.
It is of course possible to carry out this whole transaction in an outright third Wednesday date. This would reduce the impact of exchange fees (see below). However, the market structure concentrates liquidity away from these dates, and into the three-month date. With the typical bid-offer spread in third Wednesday dates – as quoted in the on-screen market – being $8 per metric ton, the cost associated with the bid-offer spread for the $1 million transaction, equates to $1,200.
Despite three-month forwards being relatively liquid, the structure of the forwards market means that for investors looking to buy and hold the cost can be much higher than for futures.
Exchange fees for forwards are also more complex. When opening and closing the position using the three-month date and an additional carry trade, this is treated as either four, five or six transactions for the purpose of calculating fees3. The non-member fee is $1.80 per lot per transaction4. For the $1 million trade as a whole, this equates to between $43.20 and $64.80. Moreover, it is market practice for non-members to cover their exchange member’s fees, which adds a further 50% to the cost, taking the total to between $64.80 and $97.20. The combined cost from bid-offer spread and exchange fees is therefore between $343.20 and $397.20 depending on market practice.
It must be noted that the position could be held at the starting three-month date. This would provide for the best liquidity and bid-offer spread to open the position, but the liquidity available to close out the trade, either through an outright trade or a carry is generally very thin, and a much higher exit cost ought to be anticipated.
|Opening Trade||bid||offer||spread||fee per lot|
|Buy||6 lots||3-Month Copper Outright||7006.5||7008||1.5||1.8|
|Buy||6 lots||3-Month – 18-Jul-18 Carry||-0.5||0||0.5||1.8|
|Sell||6 lots||3-Month – 18-Jul-18 Carry||-8.5||-8||0.5||1.8|
|Sell||6 lots||3-Month Copper Outright||6872.5||6874||1.5||1.8|
|Average spread x Number Lots x Lot Size|
|= ((1.50+0.50+0.50+1.50)/2) x 6 x 25|
|Spread Cost||= $300.00|
|Fee per lot x Number Lots|
|= (1.80 x 6) + (1.80 x 6) + (1.80 x 6) + (1.80 x 6)|
|Fee Cost||= $43.20|
Source: Bloomberg LP. See Footnote 1
In summary, for investors looking for a medium term exposure to copper, or metals more generally, the market structure means that the costs, both in terms of bid-offer spread and exchange fees, are more favourable for futures markets than in the forwards markets. In the examples described above, the costs for forwards trading are 70%-80% higher in the best-case scenario than the cost observed in futures.
This analysis has not considered the cost of brokerage. This is a significant part of the cost of a trade, but will differ for each investor and each broker. However, it should be expected that brokerage will be higher where more transactions are carried out, and where any off-screen private negotiation is required. This suggests that these fees will be higher for forwards transactions.
The data for bid-offer spreads and fees in these examples come from publicly available sources. The forwards market tends to be less transparent than futures, and superior pricing may be available privately. If your experience of the forwards markets is markedly different from that described above, we’d be very interested to hear from you.
1.Data for this analysis is for the one-month period 24 April 2018 to 24 May 2018. Quotation examples represent price levels on these dates using the modal observed bid-offer spread
2. Bid-offer spreads quoted here represent those observed on screen for the period of analysis. Better prices may be available privately, but these would be subjective and cannot be confirmed.
3. Medium-dated carry trades attract a lower fee, but the availability of this lower fee is not universal, and depends on the third Wednesday date chosen.
4. The calculation provided assumes the best-case scenario for forwards fees, where both carry trades are priced at the reduced fee for a medium-dated carry.
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All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.
Neither futures trading nor swaps trading are suitable for all investors, and each involves the risk of loss. Swaps trading should only be undertaken by investors who are Eligible Contract Participants (ECPs) within the meaning of Section 1a(18) of the Commodity Exchange Act. Futures and swaps each are leveraged investments and, because only a percentage of a contract’s value is required to trade, it is possible to lose more than the amount of money deposited for either a futures or swaps position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles and only a portion of those funds should be devoted to any one trade because traders cannot expect to profit on every trade.
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