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Contango exists for multiple reasons including inflation, carry costs , and expectations that real prices will be higher in the future. Review of the difference uses of the words contango, backwardation, contango theory and theory of normal backwardation. The spot price is the price at which an asset can be bought or sold for immediate delivery of that asset. Advanced traders can use arbitrage and other strategies to profit from contango. Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader.

Contango can be caused by several factors, including inflation expectations, expected future supply disruptions, and the carrying costs of the commodity in question. Some investors will seek to profit from contango by exploiting arbitrage opportunities between the futures and spot prices. It is important to note that futures contracts have a delivery date – they cannot be held indefinitely.

• A few fundamental factors such as the cost to carry a physical asset or finance a financial asset will inform the supply/demand for the commodity.
• However, they will generally follow the spot and futures prices while seeking to achieve the best cost efficiency.
• It is important to note though that rolling also comes with additional trading costs, both in the value of the futures contract and rolling charges.
• As a case, consider the oil price shocks in the 1970s through to the 1980s.

Contango is a situation where the futures price of a commodity is higher than the spot price. Contango usually occurs when an asset price is expected to rise over time. Contango and backwardation are terms used to describe the observed difference between the spot, or cash, price and futures prices for a commodity. The curve has two dimensions, and plots time across the horizontal axis and delivery price of the commodity across the vertical axis. This guide will break down the key differences between Contango vs Backwardation. Backwardation is when futures prices are below the expected spot price, and therefore rise to meet that higher spot price.

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This is a reason why commodities, such as gold, are perpetually offered at a premium in the futures market. As the maturation date draws near, it is always observed that the forward price of gold in contango converges downwards towards the commodity’s future spot price. The opposite is observed in backwardation, where at maturity, the forward price of gold will converge upwards towards the expected future spot price of gold. Some arbitrage opportunities may occur and this will allow traders to buy assets at spot prices and sell at future prices, pocketing the difference. In cases where inflation is rising, there is the opportunity to buy futures contracts with the expectation that prices will continue edging higher and higher as time goes by. This is an inherently risky strategy though, because it only works when prices continue to rise.

Contango, sometimes referred to as forwardation, is the opposite of backwardation. In the futures markets, the forward curve can be in contango or backwardation. Contango is a situation in which the futures price of a commodity is above the spot price. Contango has manifested numerous times in the markets throughout history. As a case, consider the oil price shocks in the 1970s through to the 1980s.

Attempting to profit from contango often involves taking risks that are not appropriate for most individual investors. Samantha Silberstein is a Certified Financial Planner, FINRA Series 7 and 63 licensed holder, State of California life, accident, and health insurance licensed agent, and CFA. She spends her days working with hundreds of employees from non-profit and higher education organizations on their personal financial plans. Think of hedging a trading strategy or using your NFT as collateral to borrow other assets.

If we go forward in time one month, we will be referring to an 11-month contract; in six months, it will be a six-month contract. Normal backwardation is when the futures price is below the expected future spot price. A normal backwardation market is often confused with an inverted futures curve.

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As mentioned, in contango, forward prices are higher than spot prices. The opposite phenomenon is backwardation, where forward prices are lower than the spot price. In contango, forward prices trade at a premium to spot prices mostly due to high carrying costs. These are costs, such as storage fees, cost of financing or insurance charges.

That happens because of the large number of buyers and sellers in the market, which makes markets efficient and eliminates large opportunities for arbitrage. As such, a market in contango will see gradual decreases in the price to meet the spot price at expiration. The futures or forward curve would typically be upward sloping (i.e. «normal»), since contracts for further dates would typically trade at even higher prices. The curves in question plot market prices for various contracts at different maturities — cf.

Consumers that want to be delivered the commodities will have no problem when the delivery date is due, but there is a concern for investors that only speculate on the underlying commodity with no intention of actually owning it. To go around this, issuers of the commodity ETF use what is known as ‘rolling’. This involves selling near dated futures and buying further dated futures of the same commodity.

What Is Contango?

The term originated in 19th century England and is believed to be a corruption of «continuation», «continue» or «contingent». In the past on the London Stock Exchange, contango was a fee paid by a buyer to a seller when the buyer wished to defer settlement of the trade they had agreed. The charge was based on the interest forgone by the seller not being paid.

But even so, at maturity, the forward price curve always converges downwards to match the prevailing spot price. If this does not happen, an arbitrage opportunity will occur in the underlying market that will basically offer “FREE MONEY” to traders. Contango is a situation where the futures price of a commodity is higher than the equity research financial modeling expected spot price of the contract at maturity. A contango market is also known as a normal market, or carrying-cost market. Whether the situation in a market is contango or backwardation, the fact that at maturity, the forward prices curve converges to meet the spot price offers immense trading opportunities for speculators.

Gold ETFs and other ETFs that hold actual commodities for investors do not suffer from contango. Backwardation describes a downward sloping curve where the prices for future delivery are lower than the spot price (e.g., the price of oil delivered in 3 months is $40/bbl and the spot tokenexus price is $50/bbl). A normal backwardation market—sometimes called simply backwardation—is confused with an inverted futures curve. Convergence is the movement of the price of a futures contract toward the spot price of the underlying cash commodity as the delivery date approaches.

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A bullish market is one in which prices make higher highs and higher lows, and this is what a contango situation in the market implies for futures prices. On the other hand, backwardation is a bearish indicator because market participants believe prices will edge lower as time goes on. Consider a futures contract we purchase today, due in exactly one year. If today’s cost for the one-year futures contract is $90 , the futures price is above the expected future spot price. Unless the expected future spot price changes, the contract price must drop.

Because the opinions and perceptions of market participants change continuously, forward price curves in the market can easily toggle between contango and backwardation. A backwardation forward curve will show lower future prices and higher spot prices. These are costs, such as storage or warehousing, insurance and forgone interest on money tied down to the commodity.

The shape of the futures curve is important to commodity hedgers and speculators. Both care about whether commodity futures markets are contango markets or normal backwardation markets. For example, an arbitrageur might buy a commodity at the spot price and then immediately sell it at a higher futures price.

Contango is a platform used to acquire, produce, develop, and manage domestic oil and gas assets. We operate in a manner that prioritizes the safety of our employees and the environment. We seek to be among the lowest cost operators in the industry and to do so while maintaining financial discipline. A front month, which is also called a near or spot month, is the nearest expiration date for a futures or options contract.

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A crude oil contango occurred again in January 2009, with arbitrageurs storing millions of barrels in tankers to profit from the contango (see oil-storage trade). The USO ETF also failed to replicate crude oil’s spot price performance. When the market is in backwardation, the futures prices for the commodity follow a downward-sloping curve in which futures prices are below spot prices. Although backwardation is relatively rare, it does occasionally occur in several commodity markets. Causes of backwardation include anticipated declines in demand for the commodity, expectations of deflation, and a short-term shortage in the commodity’s supply.

For instance, if the spot price of gold is currently $1860, and the futures price is $1950, then the commodity is said to be in contango. This is because the price of the underlying asset is expected to drift higher well into the future. Market participants are willing to pay more for the commodity in question as time goes by.

The spot rate is the price quoted for immediate settlement on a commodity, security or currency. The Structured Query Language comprises several different data types that allow it to store different types of information… The offers that appear in this table are from partnerships from which Investopedia receives compensation. Investopedia does not include all offers available in the marketplace. She holds a Bachelor of Science in Finance degree from Bridgewater State University and helps develop content strategies for financial brands.

Buy or sell at a future date

He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem. There are many jobs in finance that require knowledge of contango and backwardation. Explore our CAREER MAP to find the perfect career path for you in corporate finance.

In mid-1980, oil was priced above $100 per barrel, but by early 1986, the price had plunged to lows of circa $25 per barrel. In late 1998, the commodity was priced at around $14 per barrel, but it rallied all the way to circa $140 per barrel by mid-2008. There have been more swings forex binary options brokers since then and as of December 2020, the commodity trades in the $45 – $55 range per barrel. This fee was similar in character to the present meaning of contango, i.e., future delivery costing more than immediate delivery, and the charge representing cost of carry to the holder.