In that state, near prices become higher than far (i.e., future) prices because consumers prefer to have the product sooner rather than later , and because there are few holders who can make an arbitrage profit by selling the spot and buying back the future. A market that is steeply backwardated—i.e., one where there is a very steep premium for material available for immediate delivery—often indicates a perception of a current shortage in the underlying commodity. By the same token, a market that is deeply in contango may indicate a perception of a current supply surplus in the commodity. A carrying charge market is a futures market where long-maturity contracts have higher future prices, relative to current spot prices. Consider a futures contract we purchase today, due in exactly one year.

• If there is a near-term shortage, the price comparison breaks down and contango may be reduced or perhaps even be reversed altogether into a state called backwardation.
• Contango is a unique decentralized market offering expirables, contracts to buy or sell an asset at a set price and date in the future.
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Contango and normal backwardation refer to the pattern of prices over time, specifically if the price of the contract is rising or falling. Markets expect rising prices in futures of the said underlying asset. Review of the difference uses of the words contango, backwardation, contango theory and theory of normal backwardation. Futures prices are shaped by the dynamics between supply and demand for the contracts. 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.

Arbitrage

Producers have other reasons to pay more for futures than the spot price, thus creating contango. Producers make commodity purchases as needed based on their inventory. The spot price versus the futures price may be a factor in their inventory management. However, they will generally follow the spot and futures prices while seeking to achieve the best cost efficiency. Some producers may believe that the spot price will rise rather than fall over time.

For example, an arbitrageur might buy a commodity at the spot price and then immediately sell it at a higher futures price. As futures contracts near expiration, this type of arbitrage increases. The spot and futures price actually converge as expiration approaches due to arbitrage, and contango diminishes.

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CanTango

A front month, which is also called a near or spot month, is the nearest expiration date for a futures or options contract. 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. In a 2010 article in Harper’s Magazine, Frederick Kaufman argued the Goldman Sachs Commodity Index caused a demand shock in wheat and a contango market on the Chicago Mercantile Exchange, contributing to the 2007–2008 world food price crisis.

We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in oureditorial policy. Our mission is to create ndax review value for our shareholders through the acquisition, exploitation, exploration and development of oil and gas properties and by investing in a balanced portfolio of longer life reserves and high impact opportunities.

The USO ETF also failed to replicate crude oil’s spot price performance. “A market is ‘in backwardation’ when the futures price is below the expected spot price for a particular commodity. This is favorable for investors who have long positions since they want the futures price to rise to the level of the current spot price”. If there is a near-term shortage, the price comparison breaks down and contango may be reduced or perhaps even be reversed altogether into a state called backwardation.

Backwardation may be a result of the futures contract’s current supply and demand factors. Backwardation could indicate that traders are anticipating a commodity’s price to decline. Because the futures price must converge on the expected future spot price, contango implies futures prices are falling over time as new information brings them into line with the expected future spot price.

Understanding Contango

BackwardationBackwardation is a situation when the futures price of a commodity is lower than the spot price today. However, the commodity’s spot price can be high due to the sudden rise in demand or a disaster triggering the demand. In the practical world, most futures contracts are undertaken with the intent to settle them on or before expiry on a cash basis with no real exchange of assets through delivery, making understanding it even more important. Settlement days were on a fixed schedule and a speculative buyer did not have to take delivery and pay for stock until the following settlement day, and on that day could “carry over” their position to the next by paying the contango fee. This practice was common before 1930, but came to be used less and less, particularly after options were reintroduced in 1958. It was prevalent in some exchanges such as Bombay Stock Exchange where it is still referred to as Badla.

Thus, any change in the value of a derivative reflects the price fluctuation of its underlying asset. Such assets comprise stocks, commodities, market indices, bonds, currencies and interest rates. Conversely, a market is considered What is Ripple and How Does It Work to be in backwardation when the forward price of a futures contract is lower than the spot price of the commodity. A normal backwardation market—sometimes called simply backwardation—is confused with an inverted futures curve.

Fortunately, the loss caused by contango is limited to commodity ETFs that use futures contracts, such as oil ETFs. Gold ETFs and other ETFs that hold actual commodities for investors do not suffer from contango. A market is considered in backwardation when the forward price of a futures contract is lower than the spot price of the commodity. In case of physical assets such as commodities, the cost of carry mostly comprises storage costs and depreciation due to spoilage, decay or rotting.

In the futures markets, the forward curve can be in contango or backwardation. Peak Gold, LLC recently approved an $18 million program to complete a Feasibility Study, ready the project for permitting, and complete further resource definition and exploration drilling. The company believes that there is significant upside exploration on the 675,000-acre land package located in the heart of the Tintina Gold Belt.

Company Summary

Contango is when the futures price is above the expected future spot price. 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. As the expiration date of the futures contract approaches, the futures price will get closer to the spot price, irrespective of the futures price being at a higher or lower level. In this case, a trader will sell a futures contract for delivery at $60 while also buying enough barrels of oil at the spot price of $50 to fulfil the order at a later point.

Contango refers to a situation when the price of a futures contract of a commodity exceeds its spot price. This creates an upward sloping forward curve, which indicates that the price of the asset is expected to rise over time. 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. The most significant disadvantage of contango comes from automatically rolling forward contracts, which is a common strategy for commodity ETFs. Investors who buy commodity contracts when markets are in contango tend to lose some money when the futures contracts expire higher than the spot price.

Other costs of carry involve financial, interest and insurance costs. The price difference between futures and spot in contango is mostly related to the cost of carry, which include storing the commodity as well as depreciation costs, and more. An inverted market occurs when the near-maturity futures contracts are higher in price than far-maturity futures contracts of the same type. A futures market is normal if futures prices are higher at longer maturities and inverted if futures prices are lower at distant maturities. In 1993, the German company Metallgesellschaft famously lost more than $1 billion, mostly because management deployed a hedging system that profited from normal backwardation markets but did not anticipate a shift to contango markets. Underlying AssetUnderlying assets are the actual financial assets on which the financial derivatives rely.

For example, using your crystal ball, if you and your counterparty could both foresee the spot price in crude oil would be $80 in one year, you would rationally settle on an $80 futures price. Anything above or below would represent a loss for one of the trading contract pairs. This graph depicts how the price of a single forward contract will typically behave through time in relation to the expected future price at any point in time.

What is the opposite of contango?

It may be signaling that investors are expecting asset prices to fall over time. Overall, futures markets involve a substantial amount of speculation. When contracts are further away from expiration, they are more speculative. There are a few reasons for an investor to lock in a higher futures price. As mentioned, the cost of carry is one common reason for buying commodities futures. Contango is a situation where the futures price of a commodity is higher than the spot price.

She has conducted in-depth research on social and economic issues and has also revised and edited educational materials for the Greater Richmond area. Thus there is a negative roll return when the market dowmarkets is in ContangoContango. 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.