If I Thought Oil Prices Would Eventually Fall
By Arnold Kling
Bryan asks if it is possible to profit from unique knowledge that oil prices will start to fall in three years, given that futures markets only go out three years.
I would not call it a sure bet, but if I held those beliefs, then I would take what I believe is called a “short spread” position in the futures market. That is, I would take a short position in the futures contract that expires 36 months from now (June 2011), but I would hedge against near-term noise by taking a long position in, say, the contract that expires 6 months from now (December 2008). As a result, I am short the “spread” between the 36-month price and the 6-month price. Every six months, I would roll this position forward, so that in December I would unwind my position and short the December 2011 contract while buying the June 2009 contract. Rinse and repeat until the market begins to see the light and the short position starts to appreciate relative to the long position.
Tyler Cowen comments on Bryan’s question and other oil-related issues.