Contango vs Normal Backwardation: What’s the Difference?

Portfolio diversification, hedging strategies, and a keen eye on market trends are essential cash app down current problems and outages tools in navigating the complexities introduced by contango. Tastytrade has entered into a Marketing Agreement with tastylive (“Marketing Agent”) whereby tastytrade pays compensation to Marketing Agent to recommend tastytrade’s brokerage services. The existence of this Marketing Agreement should not be deemed as an endorsement or recommendation of Marketing Agent by tastytrade. Tastytrade and Marketing Agent are separate entities with their own products and services.

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In the volatility futures market, for example, contango often occurs because market participants expect future volatility to be higher than current volatility. Due to the negative roll yield in a contango market, these investments can underperform the spot market over the long term, even if the price of the underlying asset increases. For instance, in the oil market, contango can occur when the market expects future oil prices to rise, potentially due to anticipated geopolitical events, changes in production levels, or shifts in global demand. Similarly, interest rates can affect contango as higher rates increase the cost of carrying an asset, pushing futures prices up. Contango comes into play in the futures market, where buyers and sellers trade contracts for assets to be delivered at a future date.

What does backwardation tell us about the market?

In a contango market, an investor/trader might engage in a spread if he/she believes that prices will fall in the future. To execute the spread, the investor/trader would buy a near-term futures what is programming coding contract in favor of selling a longer-dated futures contract. That said, contango markets may also experience sharp price changes due to unexpected developments in the market. For this reason, investors and traders should adhere to disciplined risk management practices in all market environments, as contango can flip to backwardation, and vice versa at any time.

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Tastylive, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Supporting documentation for any claims (including claims made on behalf of options programs), comparisons, statistics, or other technical data, if applicable, will be supplied upon request. Tastylive is not a licensed financial adviser, registered investment adviser, or a registered broker-dealer. Options, futures, and futures options are not suitable for all investors. For example, the majority of the time, crude oil futures markets trade in contango—meaning prices are projected to increase the further one goes out on the 7 best places to buy bitcoin of 2020 the time horizon.

• This process, known as “roll yield,” can erode returns over time, particularly in steep contango markets.
• For instance, in a bond futures market, contango could occur if the market expects interest rates to fall in the future, as this would increase the value of the bonds to be delivered.
• If the market is in contango, all else equal, the manager will have to pay more for the later-dated contract than they received from selling the expiring one.
• Generally speaking, the natural state of most markets is contango—when prices gradually rise over time.

Contango vs. Normal Backwardation: What’s the Difference?

The closer the delivery date, the smaller the window for a drastic change in price. On the last day of the futures contract, the futures price becomes the spot price. As with many aspects of financial markets, success in navigating contango relies on a combination of knowledge, analysis, and adaptability. Trading in physical commodities and commodities futures can be complex, which is why investors and traders need to do extensive research prior to entering a position. If the prices of the contracts converge over time, a futures spread of this type will generally produce a profit.

Looking at an example, imagine crude oil is currently trading $70 per barrel (for immediate delivery). In a contango market, longer-dated futures contracts will be priced higher than near-term futures contracts. At the very least, contango tells us that market participants—speculators or hedgers—are expecting the asset’s prices to rise over time. Investors who buy futures contracts typically hope to lock in a price that will be lower than the spot price on the date that the contract matures. However, in a contango market, spot prices are below the futures price, meaning that the investor may have lost money over the term of the contract. The shape of the futures curve is important to commodity hedgers and speculators.

The charge was based on the interest forgone by the seller not being paid. Traders can also profit from short-selling prospects created by contango. Companies can save money by not stockpiling supplies but gradually bringing in the materials when needed. Futures are standardized agreements to buy or sell a specific asset, such as a commodity, currency, or stock, on a particular date in the future. Additionally, the role of regulatory frameworks and government policies cannot be overlooked when examining the implications of contango.

Traders and investors generally don’t want to stomach these costs, either. Many of them have no plans to take possession of the underlying commodities. Their reasons for investing are purely financial—not to buy something they have to store. They don’t need the actual commodities and will close their positions long before expiry to reduce the risk of needing to store, say, 1,000 barrels of Brent crude oil. While contango is a very common market phenomenon, there is an opposite market reaction that may come into play. Backwardation also can take place and have an impact on the delivery prices for futures.

By utilising these financial instruments strategically, market participants can hedge against adverse price movements and optimise their positions in response to changing market conditions. In the world of business finance and financial markets, certain terms and concepts are pivotal for professionals navigating the intricate landscape of investments and trading. Among these, the concept of contango plays a crucial role, especially in the commodities markets. This glossary entry aims to explore contango, offering a comprehensive understanding of its implications. For example, as shown in figure 2, as of January 2024, the nearest-term WTI crude oil futures was trading for about $71 per barrel, versus $67.44 per barrel for the June 2025 contract.

How can you tell if a futures market is in Contango or Backwardation?

Traders, on the other hand, may seek to exploit contango conditions through strategies designed to benefit from the expected price increase over time. However, this requires a deep understanding of the factors driving the contango condition and a careful analysis of market dynamics. Contango can also be influenced by geopolitical events, weather patterns affecting agricultural commodities, and technological advancements impacting production costs. These external factors contribute to the complex interplay of supply and demand dynamics that shape contango scenarios in different markets. Conversely, a market is considered to be in backwardation when the forward price of a futures contract is lower than the spot price of the commodity. Volatility futures do not always trade in contango, as there are certain high-volatility situations that may create backwardation in the futures curve.

If the price of a futures contract is above the spot price and declining over time, the market is in contango. If the futures contract price is below the spot price, the market is in normal backwardation. For example, an arbitrageur might buy a commodity at the spot price and then immediately sell it at a higher futures price. Due to the use of arbitrage, the spot and futures prices converge as expiration approaches.

Locking in a future price puts the purchaser “first in line” for delivery even though the contract will, as it matures, converge on the spot price as shown in the graph. In uncertain markets where end users must constantly have a certain input of a stock of goods, a combination of forward (future) and spot buying reduces uncertainty. An oil refiner might purchase 50% spot and 50% forward, getting an averaged price of $87.50 for the one barrel spot ($75) and the one barrel bought forward ($100). Assume the expected future spot price is $60 (the blue flat line in Figure 2 below). If today’s cost for the one-year futures contract is $90 (the red line), the futures price is above the expected future spot price. Unless the expected future spot price changes, the contract price must drop.