The risk management department of VegaBank wants to set guidelines on commodity carry trades.

To achieve a profitable commodity carry trade, the strategy should align with the market conditions represented by the shape of the futures curve. The key concepts are contango and backwardation:

Contango:

Contango occurs when the futures prices are higher than the spot prices.

To profit from contango, one should buy short-term futures contracts (which are cheaper) and sell long-term futures contracts (which are more expensive).

Backwardation:

Backwardation occurs when the futures prices are lower than the spot prices.

To profit from backwardation, one should buy long-term futures contracts (which are cheaper) and sell short-term futures contracts (which are more expensive).

Given the statements:

I. Buy short-term commodity futures and sell longer-dated position when the curve is in contango.

IV. Buy long-term commodity futures and sell shorter-dated positions when the curve is in backwardation.

Both these strategies align with the correct market conditions for profitable trades.

References

Source: How Finance Works​