Both futures and forwards offer a mechanism to manage risk and investment exposure in the commodity markets. The structure of these two types of markets is subtly different, and these differences can have implications for the relative cost of trading and investing in these products. This article examines the implications for the cost of trading in the markets for futures and forwards in metals, using the aluminum market as the example case.

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. While 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. Therefore, market liquidity is 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 is paid by the investor. In the case of futures, the active contract month has the most liquidity. When a position is opened in the active contract month, and say a month later it is closed out, this contract month is still likely to be the most active contract month, and hence offering high levels of liquidity for the closing transaction. 

As an example, take a transaction for a $1 million investment exposure in Aluminum futures at COMEX. With the contract price at $2,361 per metric ton, and a contract size of 25 metric tons, this implies a purchase of 17 futures lots. The observed bid-offer spread on the active month futures contract is $1.50 per metric ton, which equates to $37.50 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 $637.50 for the $1 million exposure.

The bid-offer spread for futures months, other than the active month, is typically $2.50 per metric ton. 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 $1.50 and $2.50 per metric ton, or $850 in total.

Exchange fees are another cost of trading that can be examined, although these can be relatively small when compared to other costs, such as the bid-offer spread, brokerage charges etc.

For futures trading, the fee structure can be straight forward. The non-member transaction fee for a screen-based transaction is $2.50 per lot, for both opening and closing the position. The total cost of the $1 million trade is $85. As a result, the combined cost from the bid-offer spread and exchange fees is $935 for this futures transaction.

Source: Bloomberg LP.  Footnote 1.

Some investors tend to hold positions for longer periods of time and prefer to roll positions forward while the position is still in the active contract month. The bid-offer spread from active month to the next month is typically $0.25 per metric ton. The cost of the bid-offer spread to roll the above trade can be calculated as $0.25 per metric ton, or $106.25.

If the trade is rolled from one month to the next month and then closed out when the next month becomes the active month, the Exchange fees would total $170, and the combined cost from bid-offer spread on the outright transactions, roll, and Exchange fees would total $913.75.

Source: Bloomberg LP.  Footnote 2.

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 the 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 aluminum 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 $6 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 ton³.

Replicating the $1 million trade example above using forwards, the contract price is nearly the same at $2,308 per metric ton, and the contract size is also 25 metric tons, requiring a transaction size of 17 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 per metric ton. For the $1 million transaction in the example, this equates to a cost $850.

Of course, it is 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 $6 per metric ton, the cost associated with the bid-offer spread for the $1 million transaction, equates to $1,275.

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 compared to futures.

Exchange fees for forwards can also be 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 fees⁴. The non-member fee is $1.94 per lot per transaction on outright trades, and $1.96 for medium dated carries⁵. For the $1 million trade as a whole, this equates to between $132.60 and $198.90. Moreover, it is market practice for non-members to cover their Exchange member’s fees as well, which adds a further 50% to the cost, taking the total to between $198.90 and $298.35. The combined cost from bid-offer spread and Exchange fees is therefore between $982.60 and $1,148.35 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.

Source: Bloomberg LP.  Footnote 1.

Rolling a position from one third Wednesday prompt date to the next can typically be done on a bid-offer spread of $0.50 per metric ton. The bid-offer roll cost can be calculated as $0.50 per metric ton, or for this example, $212.50. The total cost for this transaction as a whole is $1,228.42 when executed in the forwards market.

Source: Bloomberg LP.  See Footnote 6.

In summary, for investors looking for a medium-term exposure to aluminum, or metals more generally, the market structure means that the costs, both in terms of bid-offer spread and Exchange fees, can be significantly lower for futures markets than in the forwards markets.

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 may be higher for forwards transactions.

The data for bid-offer spreads and fees in these examples come from publicly available sources⁷. The forwards market tends to be less transparent than futures, although superior pricing may be available privately.

1. Data for this analysis is for the period 15 March 2023 to 27 April 2023. Quotation examples represent price levels on these dates using the modal observed bid-offer spread.
2. Data for this analysis is for the period 15 March 2023 to 27 April 2023, with the June/July roll taking place on April 17, 2023. Quotation examples represent price levels on these dates using the modal observed bid-offer spread.
3. 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.
4. 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.
5. 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.
6. Data for this analysis is for the period 15 March 2023 to 27 April 2023, with the June/July roll taking place on April 17, 2023. Quotation examples represent price levels on these dates using the modal observed bid-offer spread.
7. Bid-offer spreads and fees sourced from Bloomberg, CMEGroup.com, LME.com