Hedging with Jorge #Episode25: Understanding borrowing in Contango

In our previous discussion, we explored the concept of borrowing carry trades to anticipate long positions. Let’s dive deeper into how borrowing works in a contango market and why it often leads to profit.

Borrowing and Long Positions in Contango

Imagine this scenario: we’re holding a long position for April but need to shift it earlier to March. To achieve this, we sell our April position and buy for March. This process—buying an earlier position while selling a later one, is borrowing.

Now, when the market is in contango (where future prices are higher than current or earlier prices), this strategy can be profitable. Why? Because the price for March is typically lower than April. By purchasing March at a lower cost and selling April at a higher price, you capitalize on the price difference, effectively making money.

The Rule: Borrowing in Contango = Profit

Here’s a simple takeaway:

• If you’re long in April but need to be long in March, borrowing in contango means buying March at a lower price and selling April at a higher price.
• If you’re short in April and need to be short in May, you’ll buy April and sell May, also profiting from the contango curve.

A Teaser for Next Time

What happens when there’s an evacuation or significant market disruption? Stay tuned, and we’ll explore how it impacts borrowing strategies in our next discussion. Until then, remember: borrowing in contango often means you’re in the money.

See you next time!