Prices of stocks and bonds have an admirable clarity to them, because they're denominated in the terms of their payoff. If a company announces something and the stock price goes up 20%, you can usually assume that the consensus among marginal price-setters is that the present value of that company's cash flow is 20% higher per share than it was before.

But when oil futures go up 20%, it doesn't imply that. The futures price that gets quoted is the next month's future, but financial media and traders have slightly different conventions here: as each month's contracts approach expiration, traders will typically roll them forward to the next month, so at some point the next contract to expire is not the most liquid, and thus not the reference point for trading.

But you can look further out and see futures contracts for other months. Which, in a perfect world, would mean that you can use futures markets to predict where the market thinks oil will trade in any given month. But it isn't so simple because, again, these are contracts that at least nominally entitle the buyer to take delivery of 1,000 barrels of light sweet intermediate crude at Cushing, Oklahoma. It's a physical place, on a map, and if you actually look at such a map, you'll notice something odd: there's a regular city, and then to the south there are a bunch of neatly-arranged white circles. Those are oil storage tanks. And part of what the price of May, June, July, etc. futures is is that if you sell a futures contract for delivery then, and hedge your risk by buying physical oil, you're paying to move it or at least to store it.

So futures do provide a higher-dimension view of prices than purely financial assets, albeit a warped one. But this also means that they're incredibly easy to misread. At the start of March, April WTI oil futures traded at $70, hit a high of almost $120 later, and are currently in the high 80s. But go six months out, to October futures, and you see a product that started the month at $64, spiked to the low 80s, and is now back to the low 70s. The direction is roughly the same, which makes sense, and they're telling a story about higher and more volatile prices. But people trading October futures aren't adjusting prices 1:1 with the front month.

The consistent story you can tell is:

1. The attack on Iran, and the risk of long-term disruption to the Strait of Hormuz, has made oil a little scarcer. If you can lock down commitments now, you might be more inclined to do so.

2. That said, the front month is pricing in the difficulty of getting oil right now, not some long-term shift.

One of the things that makes this messy is that higher uncertainty about future oil supply increases the option value of having physical oil somewhere. If prices get really crazy—if people who were shorting futures are just one barrel short, or if there isn't enough oil to keep refineries running 24/7—it's valuable to have oil physically available. And that naturally pushes up the equilibrium rent for oil storage, which means that someone who's arbitraging by selling futures against oil they own has to bake in a higher rent. So the more valuable optionality of having oil physically close to where it gets delivered puts upward pressure on futures prices. They're pricing in volatility, as well as price level. But someone who's been doing that trade before is probably cashing in on it now, which is basically pulling supply forward.

All of this means that it's confusing to talk about "the price of oil." Do you mean the invisible long-term equilibrium price, or do you mean a current price distorted by lots of factors the market believes are temporary?

It should be a confusing question, because it's an ill-posed one. The current price of oil is always the temporary price of oil right now, and the future price of oil is either unknowable or at least something you have to pay for certainty about.

If you see situations like this, where the same product has different prices for different months of delivery, you might think of a trade that doesn't require you to store 40,000-odd gallons of fluid somewhere: why not sell an expensive near-term contract, and hedge with a cheaper contract further out? Maybe you buy August futures at $79, sell July at $82, and collect that $3 spread? There's a name for doing this trade in general: it's a calendar spread. In some markets, particular calendar spreads have another name: the Widowmaker Spread. This usually refers to the gap between March and April natural gas contracts, i.e. the gap between natural gas in the last high net demand month for heating and in the first month where it's probably net stored. Natural gas consumption is more seasonal than production, so that point in the year is when you switch from betting on the specifics of the weather—how many heating degree days, any local shortages, etc.—to a longer-term fundamental bet on the value of a molecule of methane. It's a widowmaker not just because it's volatile, but because traders have to be aware of whether they're trading based on immediate supply and demand fundamentals or longer-term sentiment.

Sometimes, stocks and bonds can have the same delivery-related kinks commodities do. A stock has a price, but short-selling is a mechanism which, like commodity futures, assumes that something will be delivered to a counterparty. A stock can be objectively expensive, but also get sufficiently hard to borrow that the price starts to rise, forcing more shorts to cover and ratcheting that effect up.

One place where this has happened a lot in the last few years is in de-SPAC transactions. Shareholders in a SPAC can redeem their stock for cash if they don't like a deal, and if the deal looks worse when it was agreed to than when it was executed, many of them will. They can get $10/share (plus interest), and they might think the business the SPAC is merging into is only worth, say, $5/share. Redeeming is a good choice in that case, and the price will tend to hug the redemption value. And you'd think that, once shareholders can't get $10/share in cash, there won't be any support for the stock and it'll collapse. Instead, high redemptions can lead to a shortage of shares—if you're right on the fundamentals, but nobody will lend you stock even if you're willing to pay 500% or more, your broker will force you to buy.

That explains otherwise odd things like the long-term chart of Grindr, which starts with an epoch where it's basically an illiquid money-market account that sometimes trades at a small premium, followed by a spike from just over $10 to the 30s when the deal closed, most SPAC shareholders redeemed, and there weren't enough shares for everyone who wanted to short. Short sellers who held on did okay; it had dropped to under $5 within two months of the SPAC deal closing (though hopefully they covered after, because it's back up above the initial SPAC price).

In a way, equities and bonds are misleading asset classes. For most of the products we own and use, there isn't a meaningful market for buying them in the future, and there isn't a good way to talk about the price other than by asking what you could pay for it right now and what tradeoffs you'd make if you didn't buy it now because you wanted to buy it later. Oil in particular exhibits extreme near-term volatility when there are disruptions to producing, moving, or refining it, because there are so many parts of the economy that need a continuous stream of oil to keep working. The front-month futures price is very real in the sense that it reflects the cost of the oil that's getting used right now, but its relationship to long-term prices is noisier than someone with an equities mindset is used to.

We’ve covered commodities and the many determinants of their pricing dynamics in The Diff:

• One thing the physical reality of oil does is it makes the US government uniquely good at betting against oil volatility ($).

• Oil demand may be more flexible than it once was ($).

• How do energy companies allocate capital when they don’t know how long the world will want oil ($)?

• Fracking is a big deal

Join the discussion!