Futures Strip

A futures strip is a collection of futures contracts stacked across sequential delivery months—say, January through December of the same year, or even multiple years. Instead of betting on a single maturity, the trader simultaneously holds or sells a ladder of expiries. It is the standard way producers, consumers, and financiers lock in average prices over an extended period.

The mechanics: building a strip

Imagine a natural gas producer that will pump steady volumes for the next two years. Rather than hedge each month individually—and face the risk of missing a market move or getting the timing wrong—the company buys a strip of 24 consecutive monthly natural gas futures contracts. Month 1 locks in the price for January delivery; month 2 for February, and so on through December of year 2.

The purchase price of each contract is the market futures price for that month, which sits somewhere on the forward curve. If the curve is in contango, distant months cost more than near months; the producer pays a cumulative premium for that certainty. If the curve is in backwardation, the producer gets a discount on distant prices and might feel it captured good value.

Once the strip is in place, the producer’s revenue is locked in. Spot prices can plummet or soar, but the hedged volumes are safe. This is risk management in its most straightforward form.

Average-price hedging

Strips excel at average-price hedging. A company does not care if January prices spike—it cares about the average price it receives over the full hedging horizon. By selling a strip of 12 contracts (say, crude oil, one month each), the firm locks in the average of 12 different market prices. The actual spot price for each month may surprise, but the hedge dampens the volatility of total revenue.

This is superior to picking a single month to hedge or trying to time the market. A manager who hedges only December delivery faces the risk that prices collapse in other months. One who hedges naively by selling spot might miss profitable rallies. A strip smooths returns across the entire period and is intellectually honest: the company says, “We sell steady volumes each month, so we hedge steady volumes each month.”

Rolling hedges and the cost of contango

As time passes, the strip “rolls forward.” January contracts expire, and the producer must close out that position (capturing whatever gain or loss from the move in spot prices). The producer then buys a new contract further out the curve—for example, in year 2 or year 3.

If the forward curve is in contango, rolling is costly. The new contract is more expensive than the old one, creating a slippage in the average price locked in. Over time and across many rolls, contango can erode the hedging gains of a strip, especially for long-dated exposures. This is why energy producers closely monitor contango steepness; a very steep curve signals that rolling hedges will be expensive.

Conversely, in backwardation, rolling is profitable. The producer closes the expiring contract at a gain and buys the new contract at a discount. Backwardation rewards those holding inventory and rolling hedges forward.

The strip in practice: commodities and rates

In crude oil and natural gas markets, strips are ubiquitous. A futures commission merchant might handle dozens of strips for energy firms on any given day. The mechanics are straightforward but the economics are subtle: the producer must choose a strip length (one year, three years, five years?), decide whether to hedge 100% of production (risky if volumes change) or a percentage (adds complexity), and monitor the cost of rolling.

In interest rate markets, futures strips serve a similar role. A bank borrows short-term repeatedly, facing interest rate risk each time it rolls. By buying a strip of Eurodollar futures or Treasury futures, the bank locks in a chain of rates and neutralises interest rate risk. The economics are identical to commodity hedging: the strip locks in an average cost of funds.

Risks and complications

A strip is not a perfect hedge. First, there is basis risk—the difference between the futures price and the actual spot price at delivery. A producer selling a crude oil strip is hedged against the futures price moving, but not against the local spot basis (the premium or discount of Brent crude vs. WTI, for example) shifting. This is usually small but real.

Second, there is volume risk. The producer assumes steady production. If drought cuts grain output or a refinery closes unexpectedly, the producer is over-hedged—it must sell physical at spot prices while holding excess futures positions. Conversely, if production surges, the producer is under-hedged and exposed. Sophisticated hedgers build flexibility into their strips, leaving a percentage unhedged.

Third, there is liquidity risk. Contracts near the front of the curve are highly liquid; distant contracts (say, five years out) may have sparse order books. Entering or exiting a large strip on a thin market can move prices against the trader.

Finally, there is the mark-to-market effect. As prices move, the strip’s value changes daily, creating cash flow demands via margin calls. A producer that sells a crude oil strip and prices rally must post margin to keep the position open. This can stress cash flow if not managed properly.

Strips versus other hedging strategies

A strip is simpler and more transparent than buying a single far-dated forward contract (which requires finding a counterparty willing to lock in a two-year price, and entails counterparty risk). Strips are also more flexible than options; a producer paying for protective put options on each month sacrifices gains to the upside.

In practice, many hedgers combine strategies. A producer might sell a strip of futures (locking in a floor), then buy out-of-the-money call options to retain upside above the strip price. This creates a “collar”—defined risk, defined opportunity cost, and a cap on profit. It is more expensive than a pure strip but matches the risk appetite of management.

See also