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Looking at oil prices now(https://www.cmegroup.com/trading/energy/crude-oil/light-sweet-crude.html)

May Futures - $20

June Futures - $26

Spot - $20

With price convergence theory, may futures matches closely with spot. This makes sense.

However, May futures are rolling over soon(Apr 21). Once rolled over, June futures become the main futures contract in variety of oil ETFs(USO, etc)

Assuming a scenario where the above prices remain constant until rollover date:

  1. When this happens, does June futures start to decline to match closer with spot price?(June futures goes from 26 to 23, for example).

  2. If this above happens, does this happen quickly? Does this not create opportunity for arbitrage, where you can buy inverse ETFs to profit off of the convergence of June futures to spot oil?

Thanks!

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    $\begingroup$ All financial products will be based on the future, the only way to close the arbitrage would be to buy spot oil and keep it (physically) for one month. However all tankers and facilities are pretty much full already, that's why in some delivery points in the US the price went negative. $\endgroup$ – Lliane Apr 17 at 11:19
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The price of the future also depends on the amount you need to spend to hold your position. This can come in the form of interest payments to fund your investment, forex fees as well as insurance and storage costs. This is typically known as cost of carry. Often times another factor comes into play, and we can observe a "hump" for the next 1-2 futures contracts, which is caused by the so called "convenience yield" (A premium which is related to the benefit of having access to the commodity when there is a possible scarcity). You can read more about this and the shape of the futures curve by looking up Contango and Backwardation.

$F = Se^{(r + s - c) t}$

r = risk free rate; s = storage (insurance etc.); c = convenience yield

This price difference does and should typically not create an opportunity for arbitrage, at least not for common traders. The prices will converge slowly until rollover date. Also if you were to buy the June 2020 future now at a price of 26, you would lose money, even if the spot price went from 20 to 25. So the price of 26 indicates that there currently is an agreement between market participants that by expiry of the June contract, the Spot price will be at 26. Changes in supply and demand will of course constantly change both, the spot and the future prices.

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    $\begingroup$ hi Andreas: thanks for your respoonse. My question is actually a lot more simple minded - when May contracts expire/roll over on Apr 23, on investing.com, June contracts become the 'primary' futures product for this month. My question is - when that happens, and spot price remains at 20, does the June futures immediately begin to move towards the 20 mark, or will it take time(1 or 2 weeks), so long as spot holds at 20 $\endgroup$ – Daruki Apr 17 at 13:59
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    $\begingroup$ They should gradually get closer, with the speed of convergence depending on the factors I've mentioned. Also, let's take todays drop in WTI as an example: the spot and future both dropped today. Depending on the expectations of market participants regarding the oil price at the expiry of the June contract the future price can drop more or less than the spot price. It is also not a given, that the future has to be above the spot. If traders expect lower demand for oil or if there is indeed a lower demand, due to economic slowdown, futures can go below the spot. $\endgroup$ – Andreas Apr 17 at 14:09
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    $\begingroup$ Thanks, Andreas. The story i hear online is that on contract rollover date(Apr 23), if spot is 20, and June futures is at 26, then in a day, if spot is still 20, then June futures will meet spot in the middle at 23. Doesn't sound likely to me. What do you think? $\endgroup$ – Daruki Apr 17 at 18:56
  • $\begingroup$ That is highly unlikely in general and especially "in a day". As mentioned, the two will converge eventually and given everything else stays as is, it should happen gradually. But again, there is also the possibility that they will diverge for a few days and end up converging faster afterwards. $\endgroup$ – Andreas Apr 18 at 6:56
  • $\begingroup$ @Daruki please consider "accepting" the answer in case it helped you. Thanks! See stackoverflow.com/help/someone-answers or meta.stackexchange.com/questions/5234/… $\endgroup$ – Andreas Apr 19 at 14:05

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