Expiry of options/futures contract - effect on ETFs?

andyandy · 24th November 2011, 04:21 AM

OK, had a look for this online but could do with some clarification....

Quote:

Q. What is Contango and Backwardation?

A: Contango and backwardation are industry terms that are applicable to the futures commodity markets. Contango in practice means that the commodity price for future delivery trades above the 'spot' price (that is quoted for immediate or near-term settlement) while backwardation refers to market situations where the price is lower than the 'spot' price.

In other words a 'contango' situation occurs when oil prices for future delivery are higher than the current oil price. This phenomenon has caused erosion on funds that invest in near-term futures contracts based on the price of oil, so ETF investments may not be as simple as they seem. Do consult a stockbroker if you are keen on investing in ETFs.

For example, a crude oil contango situation happened in the first half-year of 2009 where market participants and oil companies stored many millions of barrels of crude oil in tankers in an attempt to make an easy gain. This created a market ambiguity which persisted for the remainder of the year and explained the discrepancy between the increase in the spot oil price and the various tradeable instruments for crude oil like ETFs. While the physical spot oil price fell to about $34 and peaked at the $80's levels, longer-dated futures reflected more modest price increases.

Backwardation on the other hand is a rare phenomenon in the world of futures trading but usually indicates a market where there is uncertainty in the immediate future on the supply or situations where there is a sharp increase in near-term demand. In practice it means that buyers would prefer to have delivery of the commodity now - even if they could end up paying less for future delivery. For an investor in a commodity-based exchange traded fund this is usually positive news as it may allow fund managers to roll futures commodity contracts (i.e. sell and buy new contracts) at a discount since the expiring contracts will trade at a premium to the longer-dated contract being acquired.
Q. How does Contango affect ETF's prices?

A: OK, to explain this let's pick USO (which is the highest volume Oil exchange traded fund). USO does not own any physical crude oil, it just buys futures contracts... USO uses those future contracts to hedge itself - and, since positions have to be rolled forward regularly to prevent taking physical delivery, it is not easy to outperform the market prices. This is because with Contango you have to pay a premium to move into the next monthly contract so a profit can only be realised if the positive price movements are greater than the losses generated by the rollover itself (i.e. the premium paid to remain in the position). So while to many people the low price of oil may look like a great buying opportunity, the current state of the market means, more than likely, they will generate a loss just because of the roll. The conclusion, is that USO is not a direct play on the spot price of crude oil, it is, instead, a play on the spot price, forward prices, and the relationship between spot and forward. Check out this site to see for yourself the extent to which Contango will affect future oil ETFs. Thus, in Contango, it is probably better to buy shares of companies with oil 'in the ground' so they do not need to pay the high forward premiums (which tend to be connected to storage costs).

http://www.financial-spread-betting....-seminars.html

Is this likely to mean there is a downward pressure on ETF prices as options on futures expire?

Do ETFs hold futures contracts or options on futures? Do futures expire on the same set days as options?

What's the best way to monitor the % loss due to roll overs?

Any more info would be useful

kevsta · 24th November 2011, 04:33 AM

Originally Posted by andyandy

OK, had a look for this online but could do with some clarification....

http://www.financial-spread-betting....-seminars.html

Is this likely to mean there is a downward pressure on ETF prices as options on futures expire?

Do ETFs hold futures contracts or options on futures? Do futures expire on the same set days as options?

What's the best way to monitor the % loss due to roll overs?

Any more info would be useful

IMO there is definitely cyclical downwards pressure as the gap to options expiry grows smaller. This is getting into the realms of market manipulation CTs, but anyone trading or observing price action cannot fail to notice that prices always move towards less pain (for options writers) and less profits for speculators as the time draws closer.

ie. we rarely (if ever, I have never) seen these big smackdowns after people have made fortunes on their options, interestingly they are always before expiry, and then the prices seem free to run afterwards.

many traders I know have the dates integrated into their trading strategies.

this might help you http://www.clarkfinancial.com/max-pain-calculator.html

andyandy · 25th November 2011, 04:31 AM

...for example - the ftse 100 has just dropped from 5500 - 5100 in the past 2 weeks, whereas the ETF gold fund (PHAU) has also dropped from 175 - 165. Is that decline in any way linked to the option expiry last saturday, or is that unconnected? And if it is unconnected, then why are we seeing both a decline in the stock market (and across the US/Europe) and a decline in the gold price?

cheers

kevsta · 25th November 2011, 05:29 AM

Originally Posted by andyandy

...for example - the ftse 100 has just dropped from 5500 - 5100 in the past 2 weeks, whereas the ETF gold fund (PHAU) has also dropped from 175 - 165. Is that decline in any way linked to the option expiry last saturday, or is that unconnected?

I think it would be difficult to draw any definite conclusions about micro cycles (options expiry) within the overall macro context of the ongoing European meltdown to be honest.

Originally Posted by andyandy

And if it is unconnected, then why are we seeing both a decline in the stock market (and across the US/Europe) and a decline in the gold price?

cheers

Stock markets are "risk assets" and hence when major credit meltdowns are underway stocks get sold off, along with anything else that is relatively liquid, (ie easy to sell if you need money) including gold. more on this here

andyandy · 25th November 2011, 06:32 AM

Originally Posted by kevsta

Stock markets are "risk assets" and hence when major credit meltdowns are underway stocks get sold off, along with anything else that is relatively liquid, (ie easy to sell if you need money) including gold. more on this here

thanks for the link - interesting. Is there any asset class that more closely tracks the inverse movements of the stock market (not counting short ETFs etc) - or is gold as close as we've got?

kevsta · 25th November 2011, 06:38 AM

there are multiple ETFs, inverse and otherwise, but Im not really up with anything paper-based.

I see traders talking about 2x and 3x leveraged ETFs for everything though, but from what I understand lots of those have built in "decay" and so are effectively rigged against you for anything but day trading.

I would have thought that lots of the anti Gold JREFers round here would be loaded up to the gills with the 3x negative Gold ones though

edit here ya go http://www.tradermike.net/inverse-sh...ish-etf-funds/

be very careful with anything like that though, always bear in mind that 90% of the market participants lose.

edit 2, ah sorry, I missed the "not counting short ETFs". answer, I dont know.

24th November 2011, 04:21 AM	#1
andyandy anthropomorphic ape Join Date: Apr 2006 Location: up a tree Posts: 8,192	Expiry of options/futures contract - effect on ETFs? OK, had a look for this online but could do with some clarification.... Quote: Q. What is Contango and Backwardation? A: Contango and backwardation are industry terms that are applicable to the futures commodity markets. Contango in practice means that the commodity price for future delivery trades above the 'spot' price (that is quoted for immediate or near-term settlement) while backwardation refers to market situations where the price is lower than the 'spot' price. In other words a 'contango' situation occurs when oil prices for future delivery are higher than the current oil price. This phenomenon has caused erosion on funds that invest in near-term futures contracts based on the price of oil, so ETF investments may not be as simple as they seem. Do consult a stockbroker if you are keen on investing in ETFs. For example, a crude oil contango situation happened in the first half-year of 2009 where market participants and oil companies stored many millions of barrels of crude oil in tankers in an attempt to make an easy gain. This created a market ambiguity which persisted for the remainder of the year and explained the discrepancy between the increase in the spot oil price and the various tradeable instruments for crude oil like ETFs. While the physical spot oil price fell to about $34 and peaked at the $80's levels, longer-dated futures reflected more modest price increases. Backwardation on the other hand is a rare phenomenon in the world of futures trading but usually indicates a market where there is uncertainty in the immediate future on the supply or situations where there is a sharp increase in near-term demand. In practice it means that buyers would prefer to have delivery of the commodity now - even if they could end up paying less for future delivery. For an investor in a commodity-based exchange traded fund this is usually positive news as it may allow fund managers to roll futures commodity contracts (i.e. sell and buy new contracts) at a discount since the expiring contracts will trade at a premium to the longer-dated contract being acquired. Q. How does Contango affect ETF's prices? A: OK, to explain this let's pick USO (which is the highest volume Oil exchange traded fund). USO does not own any physical crude oil, it just buys futures contracts... USO uses those future contracts to hedge itself - and, since positions have to be rolled forward regularly to prevent taking physical delivery, it is not easy to outperform the market prices. This is because with Contango you have to pay a premium to move into the next monthly contract so a profit can only be realised if the positive price movements are greater than the losses generated by the rollover itself (i.e. the premium paid to remain in the position). So while to many people the low price of oil may look like a great buying opportunity, the current state of the market means, more than likely, they will generate a loss just because of the roll. The conclusion, is that USO is not a direct play on the spot price of crude oil, it is, instead, a play on the spot price, forward prices, and the relationship between spot and forward. Check out this site to see for yourself the extent to which Contango will affect future oil ETFs. Thus, in Contango, it is probably better to buy shares of companies with oil 'in the ground' so they do not need to pay the high forward premiums (which tend to be connected to storage costs). http://www.financial-spread-betting....-seminars.html Is this likely to mean there is a downward pressure on ETF prices as options on futures expire? Do ETFs hold futures contracts or options on futures? Do futures expire on the same set days as options? What's the best way to monitor the % loss due to roll overs? Any more info would be useful
	__________________ "Contentment is found in the music of Bach, the books of Tolstoy and the equations of Dirac, not at the wheel of a BMW or the aisles of Harvey Nicks."

24th November 2011, 04:33 AM	#2
kevsta RBL CHeck Failed Join Date: Jun 2007 Location: in the shadows Posts: 2,404	Originally Posted by andyandy OK, had a look for this online but could do with some clarification.... http://www.financial-spread-betting....-seminars.html Is this likely to mean there is a downward pressure on ETF prices as options on futures expire? Do ETFs hold futures contracts or options on futures? Do futures expire on the same set days as options? What's the best way to monitor the % loss due to roll overs? Any more info would be useful IMO there is definitely cyclical downwards pressure as the gap to options expiry grows smaller. This is getting into the realms of market manipulation CTs, but anyone trading or observing price action cannot fail to notice that prices always move towards less pain (for options writers) and less profits for speculators as the time draws closer. ie. we rarely (if ever, I have never) seen these big smackdowns after people have made fortunes on their options, interestingly they are always before expiry, and then the prices seem free to run afterwards. many traders I know have the dates integrated into their trading strategies. this might help you http://www.clarkfinancial.com/max-pain-calculator.html
	__________________ "The world will soon wake up to the reality that everyone is broke and can collect nothing from the bankrupt, who are owed unlimited amounts by the insolvent, who are attempting to make late payments on a bank holiday in the wrong country, with an unacceptable currency, against defaulted collateral, of which nobody is sure who holds title." - Anonymous

25th November 2011, 04:31 AM	#3
andyandy anthropomorphic ape Join Date: Apr 2006 Location: up a tree Posts: 8,192	...for example - the ftse 100 has just dropped from 5500 - 5100 in the past 2 weeks, whereas the ETF gold fund (PHAU) has also dropped from 175 - 165. Is that decline in any way linked to the option expiry last saturday, or is that unconnected? And if it is unconnected, then why are we seeing both a decline in the stock market (and across the US/Europe) and a decline in the gold price? cheers
	__________________ "Contentment is found in the music of Bach, the books of Tolstoy and the equations of Dirac, not at the wheel of a BMW or the aisles of Harvey Nicks."

25th November 2011, 05:29 AM	#4
kevsta RBL CHeck Failed Join Date: Jun 2007 Location: in the shadows Posts: 2,404	Originally Posted by andyandy ...for example - the ftse 100 has just dropped from 5500 - 5100 in the past 2 weeks, whereas the ETF gold fund (PHAU) has also dropped from 175 - 165. Is that decline in any way linked to the option expiry last saturday, or is that unconnected? I think it would be difficult to draw any definite conclusions about micro cycles (options expiry) within the overall macro context of the ongoing European meltdown to be honest. Originally Posted by andyandy And if it is unconnected, then why are we seeing both a decline in the stock market (and across the US/Europe) and a decline in the gold price? cheers Stock markets are "risk assets" and hence when major credit meltdowns are underway stocks get sold off, along with anything else that is relatively liquid, (ie easy to sell if you need money) including gold. more on this here
	__________________ "The world will soon wake up to the reality that everyone is broke and can collect nothing from the bankrupt, who are owed unlimited amounts by the insolvent, who are attempting to make late payments on a bank holiday in the wrong country, with an unacceptable currency, against defaulted collateral, of which nobody is sure who holds title." - Anonymous Last edited by kevsta; 25th November 2011 at 06:08 AM.

25th November 2011, 06:32 AM	#5
andyandy anthropomorphic ape Join Date: Apr 2006 Location: up a tree Posts: 8,192	Originally Posted by kevsta Stock markets are "risk assets" and hence when major credit meltdowns are underway stocks get sold off, along with anything else that is relatively liquid, (ie easy to sell if you need money) including gold. more on this here thanks for the link - interesting. Is there any asset class that more closely tracks the inverse movements of the stock market (not counting short ETFs etc) - or is gold as close as we've got?
	__________________ "Contentment is found in the music of Bach, the books of Tolstoy and the equations of Dirac, not at the wheel of a BMW or the aisles of Harvey Nicks."

25th November 2011, 06:38 AM	#6
kevsta RBL CHeck Failed Join Date: Jun 2007 Location: in the shadows Posts: 2,404	there are multiple ETFs, inverse and otherwise, but Im not really up with anything paper-based. I see traders talking about 2x and 3x leveraged ETFs for everything though, but from what I understand lots of those have built in "decay" and so are effectively rigged against you for anything but day trading. I would have thought that lots of the anti Gold JREFers round here would be loaded up to the gills with the 3x negative Gold ones though edit here ya go http://www.tradermike.net/inverse-sh...ish-etf-funds/ be very careful with anything like that though, always bear in mind that 90% of the market participants lose. edit 2, ah sorry, I missed the "not counting short ETFs". answer, I dont know.
	__________________ "The world will soon wake up to the reality that everyone is broke and can collect nothing from the bankrupt, who are owed unlimited amounts by the insolvent, who are attempting to make late payments on a bank holiday in the wrong country, with an unacceptable currency, against defaulted collateral, of which nobody is sure who holds title." - Anonymous Last edited by kevsta; 25th November 2011 at 06:46 AM.