Contango vs Backwardation Top Differences with Infographics

Conversely, consumers of commodities may face higher costs, impacting budgeting and financial planning. Contango has significant implications for various stakeholders in the financial markets. For investors and traders, understanding contango can provide valuable insights into market trends and potential investment strategies. Backwardation occurs when the future price of a commodity is lower than its spot price. This situation is less common but can arise in markets where there is an expectation of a decrease in the price of the commodity over time. Commodity-heavy industries, such as oil and gas, precious metals, and agriculture, are more susceptible to contango due to the tangible nature and storage costs of their products.

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If futures prices are higher than spot prices, traders anticipate rising prices. According to the theory of storage, contango should be the norm for commodity markets due to the inherent costs of storage. However, markets frequently alternate between contango and backwardation due to ever-changing supply and demand dynamics. From a strategic perspective, contango offers both challenges and opportunities. For commodity producers, contango may signal favourable conditions for locking in future prices, providing revenue certainty.

Contango can be costly for traders and investors who roll over futures contracts. As each expiring contract is replaced by a more expensive one, the strategy generates a negative roll yield, reducing overall returns. Traders benefit as futures prices tend to rise and converge with the spot price before expiry, effectively boosting returns.

Explore market opportunities, test your strategies risk-free with a VT Markets demo account, and take advantage of advanced tools to navigate pricing structures like contango and backwardation with confidence. At VT Markets, we offer access to a wide range of futures-linked instruments and commodities through powerful platforms like MetaTrader 4 (MT4) and MetaTrader 5 (MT5). Whether you’re trading energy, precious metals, or indices, our platform is built to support both new and experienced traders with competitive spreads and 24/5 access to our comprehensive Help Centre. The market conditions that may lead to contango may also cause backwardation.

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For example, there might be concerns about regulatory changes or negative news affecting the price of Bitcoin. However, I wanted to give you this information to make sure that you understand the difference between Contango and Backwardation, and how that affects the price of the underlying futures contract. Otherwise, traders can take advantage of the “contango bleed” and profit from short volatility positions as long as market volatility does not surge. Extreme market volatility typically does not last long, which is precisely why long-dated VIX futures will trade at steep discounts to spot VIX during periods of significant market volatility. For example, if the Cboe VIX index is at 15 and the VIX futures contract settling in 30 days is 17, we have contango in the VIX futures market. Investors entering long positions at discounted futures prices can gain an edge as prices rise closer to the spot.

A market that has steep backwardation—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. 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. Fortunately, the loss caused by contango is limited to commodity ETFs that use futures contracts, such as oil ETFs. In most markets, prices tend to rise over time because of inflation and storage costs.

• In ETFs, especially those that track specific sectors or commodities, contango can cause underperformance if the fund is forced to roll over futures contracts.
• For example, if an economic recession is expected to develop, markets may go into backwardation to account for slowing demand, which often has a negative impact on price.
• It also leads to negative rolling returns as futures prices are always higher than the spot prices resulting in rolling costs for each monthly rollover.
• It describes a situation where the futures price of a commodity is higher than the expected future spot price.

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An oversupply of a commodity may lead to lower current prices as producers and traders seek to sell their inventories quickly. However, when demand is expected to rise, the commodity’s price for future delivery increases. This can create a situation where the future price of the commodity is higher than the current spot price.

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Contango is often observed in markets with high storage capacity and low short-term demand, such as crude oil or gold during calm economic periods. Backwardation is more common in commodities sensitive to seasonal demand or geopolitical stress, such as natural gas during winter or agricultural products during supply disruptions. The structure of futures contracts and forward contracts includes specific expiration dates, expiry dates, and delivery dates. As the contract expires or the futures contract expires, the futures price and spot price converge, and the delivery price becomes equal to the spot price. how do real estate brokerages work what to know as a potential client You should familiarise yourself with these risks before trading on margin. Contango is the market condition in which the price of a commodity futures contract is currently trading higher than the spot price of the underlying.

• This means that the price of a commodity for future delivery is less expensive than the current spot price.
• This situation is desirable for speculators holding long positions, as it indicates that futures prices are increasing.
• On the other hand, spot prices are what you’d pay to buy a commodity for “immediate delivery”.
• These costs are incurred to hold the underlying commodity until the delivery date, and they are reflected in the delivery price of the futures or forward contract.

There is no guarantee that the advice given will result in profitable trades. A futures market is normal if futures prices are higher at longer maturities and inverted if futures prices are lower at distant maturities. A normal backwardation market—sometimes called simply backwardation—is confused with an inverted futures curve. Contango can be seen as bearish because it often signals an oversupply of the commodity or a lack of immediate demand. what is bitcoin mining and how it works 2020 It suggests that traders expect prices to increase in the future rather than seeing immediate market strength, which can indicate market weakness.

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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. This means investors are willing to pay more to take possession of the commodity in the future. Traders with access to physical oil and storage can make substantial profits in a contango market. Other traders may seek to profit on a storage shortage by placing a spread trade betting on the contango structure of how to buy verasity coin the market to increase.

How does contango affect traders and investors?

Most futures are typically in Contango, meaning that the price of the futures in further dated expirations is higher than that of the near term. The most critical concept to understand is that volatility products are tied to VIX futures, which converge to the VIX index over time. But market volatility is always changing, and periods of extreme market volatility typically do not last long.

Going back to the example, say a trader believes that the spot price of oil will go even lower versus the future month’s contract. A trader would short the spot month contract and buy the further out month. I hate to say it, but it’s become a popular notion to say that the market is in Contango, in this case, Brent Crude. The market is in Contango if all the futures contracts with different expirations have prices higher than the spot price. For investors using commodity ETFs or funds tied to futures (such as oil, gas, or metals), the shape of the futures curve matters significantly. ETFs that roll contracts monthly can suffer in contango, while they tend to perform better in backwardation.