Still have tough time with contango and backwardization. EOC 7 gives a first month future and second month future . To profit from a carry roll-down we buy the front month future and sell the second month future.
Spot is at 13.50 with first month at 14.10 and second month at 15.40. I realize this is in contango, and futures prices will converge to the spot VIX (13.50) by expiration.
The solution say difference between first month future and spot VIX is 0.60. DIfference between second month future and first month future is 1.30.
Then I don’t understand solution. Why do we realize roll down gains as the spread decreases from 1.30 to .60 as the first month futures approachs its expiration (right from solution)? And how does this relate to buying first month and selling second month future?
So confused. thanks
From the text it says, assuming a basis declines linearly and the term structure is in contango the trader who is long the back month would realize losses. I’m assuming if we’re short the back month, we would realize gains then. I dont understand this though. If somebody could explain that, thank you.