Reviewed by Oct 05, 2020| Updated on
A futures strip is a single purchase of multiple futures contracts, spread over a period of time. By doing so, traders lock in a specific price for a particular time frame. The buying or selling of these futures contracts is in sequential delivery months, but it is traded as one single transaction.
Traders use a futures strip to speculate on prices of the underlying commodity, and typically do this when the futures contracts have high liquidity over a time horizon. These are commonly used in commodity markets, such as agricultural goods, oil, and natural gas.
One of the main advantages of purchasing future strips is hedging. Futures contracts are a popular means of hedging, as they are highly liquid instruments.
A strip hedge or a futures hedge is a single purchase of a series of futures contracts spread over a consecutive time period. There is no basis risk in this type of a hedge, as the basis is locked and changes to the basis cannot affect the risk. A strip hedge is used when there is high liquidity on futures contracts over a longer time horizon.
A stack hedge, on the other hand, is purchasing a set of futures contracts for a nearby delivery date, and on that date, rolling the position forward by purchasing further futures contracts.
The process will continue for future delivery dates until each position’s maturity exposure is hedged. In this case, the basis risk is locked in only for the initial set of futures. A stack hedge is used when there is limited longer-term liquidity, and hence higher liquidity instruments with a short maturity are used.
Trader A buys a six-month oil futures strip, by purchasing an equal number of oil futures for each of six consecutive months through a single purchase. The purchase of the futures strip could be to hedge against fluctuations in the underlying commodity or derivative, in this case, oil. The other reason to purchase a futures strip could be to speculate on rising prices in the underlying market.