Time decay of futures

Question

Web site such as this one here state that futures contracts do not experience time decay. I fail to see why futures do not experience time decay.

The way I see it (perhaps incorrectly) is like this: If the price of widgets is $100/Bb and I buy a futures contract for delivery in one year, I will have to pay $100 for one bushel of widgets in one year (provided that I don't sell the contract first). If the price of widgets goes down to $20/Bb and seems to stay there, my futures contract is way out of the money. It becomes a mostly unwanted contract as the delivery date nears. Anyone purchasing my contract will have to pay $100 for the bushel to be delivered when they could just turn around and buy it for $20 as spot. This is time decay if I understand it. Where have I gone wrong in my understanding?

Answer 1

In this case, you have suffered a loss, but it's not due to the passage of time; it's due to the market moving against your position. If the market was flat over an extended period, your future would have no gain or loss (ignoring effects of interest, storage costs, etc.).

Futures, unlike options, do not have a strike price and are not in or out of the money. All futures with a given underlying and expiration are the same: an obligation for the seller to deliver the underlying to the buyer at expiration. The price of your transaction is not a strike; it is simply what you paid for the future. You don't actually pay that amount up front because you can make a relatively small initial deposit (margin), and your subsequent gains and losses relative to the purchase price are marked to market.

There also exist options on futures (futures options), which behave much like options on stocks and indexes, but you are asking about plain futures.

EDIT: Another viewpoint that might help, if you are more familiar with options: A future is somewhat like a European call option with $0.00 strike, with the feature that you can use margin to buy it or short it. In this sense, it has zero time value (hence no time decay) and is always in the money.

Answer 2

Actually there are carry charges for warehousing & insurance (for physical commodities) plus other costs that are factored into the cost of the futures contract. These tend to be at a maximum in the back months and a minimum at contract delivery when the cost is essentially at the current spot price. So you could say these costs "decay" as you approach delivery for physical commodities.