This supply/demand interplay ultimately determines the shape of the futures curve. Spot prices, on the other hand, are what a commodity would sell for if you were to buy it right now and take immediate delivery. So, if futures prices are higher than spot prices, it means traders expect prices to rise. These exchange-traded funds don’t own physical assets—they take up too much space and have a high cost of carry.
What’s Contango and What Does It Tell Investors?
To profit from this advance knowledge, an investor may exit other positions that could be hurt by rising prices. This is because when the ETF rolls their contracts over, they might have to renew those contracts at a higher price. As an investor, you could make money by short selling these ETFs (a trade that makes money when the price of the ETF goes down). For example, this could happen if investors expect a future supply surge for a commodity, a major drop in demand, or the economy is in a state of deflation, where prices are falling usually due to a recession. Contango and normal backwardation refer to the pattern of prices over time, specifically if the price of the contract is rising or falling. These futures often trade in contango because market participants generally expect volatility to rise in the future.
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. Contango can create opportunities for commodity arbitrage, a strategy where traders aim to profit from price discrepancies in different markets. 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. A futures contract is an agreement to buy or sell a commodity, currency, or a standardized asset (like a stock index) on a specific date in the future. For example, a contango situation in the oil market can lead to a sharp decrease in oil prices, affecting oil-producing nations’ revenues while benefiting consumers and industries that rely heavily on oil. Additionally, contango can shape market structures and drive innovation in financial products, impacting various sectors of the global economy.
However, during periods of market stress, volatility futures can shift into backwardation as market participants expect volatility to decrease over time. In other words, contango roll yield typically results in fund returns that lag the performance of the underlying asset. And this is how a single commodity or financial product can reflect different prices. Buyers and sellers will bid them up or offer them down, depending on what they expect the price to be by the time it reaches its delivery month.
This price structure is due to factors such as storage costs, interest charges, and market expectations about future price movements. Futures contracts investors expect to buy or sell commodities at a fixed price on a specific date in the future. When prices are higher, this creates contango and when they are lower, that is known as normal backwardation. These scenarios create opportunities for investors to generate a profit by taking advantage of the market dislocations.
- The COVID-19 crisis led to a significant stretch of contango in the oil markets.
- This creates an upward sloping curve of future prices over time relative to the current spot price.
- High-interest rates can contribute to a contango market because they increase the cost of carrying an asset, pushing up futures prices.
- When contango occurs, investors must pay more attention to their futures contracts within their portfolios.
Most commodity ETFs use rolling contracts, where they keep exchanging their existing short-term futures contracts before they expire for new ones. If prices go up, they lose money on the exchange each time, hurting their performance. This creates an upward sloping curve of future prices over time relative to the current spot price. It involves factors like storage costs, interest rates, and market sentiment. Awareness of contango’s implications in diverse market conditions and its association with volatility is crucial for navigating the complexities of futures trading. Understanding the dynamics between contango and normal backwardation is crucial for investors and traders, as they provide insights into market expectations and can influence trading strategies.
Correlation Between Contango and Volatility
At the very least, contango tells us that market participants—speculators or hedgers—are expecting the asset’s prices to rise over time. 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. 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. In an inverted market, the futures price for faraway deliveries is less than the spot price. 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.
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. Gold ETFs and other ETFs that hold actual commodities for investors do not suffer from contango. 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). Because investors base their futures bids on how they foresee the market turning out, sentiment plays a significant part in backwardation.
A market is “in backwardation” when the futures price is below the spot price how much money can you make trading ethereum how much to buy ethereum uk for a particular asset. In general, backwardation can be the result of current supply and demand factors. It may be signaling that investors are expecting asset prices to fall over time.
Which of these is most important for your financial advisor to have?
The structure of a contango can be visualized through a futures curve, which plots the prices of futures contracts against their expiration dates. Let’s say it’s January and a given commodity is higher in August compared to now (contango). By the time August rolls around, the futures price may fall or the spot price may rise (or both) to meet at the same price point when the contract expires. This happens for many reasons, such as greater than expected demand, inflation and supply disruptions.
They might want to keep production running smoothly, and perhaps they’re anticipating a supply disruption or tighter supply conditions in the coming months. So, they buy most of their commodities in the near term rather than risk paying higher prices later (which can happen if supply gets tight enough). The result is that the cash or “spot”price of the commodity shoots up, making it more expensive now than in later months, creating a backwardated what is bitcoin and why is the price going up 2021 market.
If you think the market has pushed the futures price too high because of contango, you could agree to sell a futures contract at the higher price. As an investor, consider what you think how to detect if someone is using a vpn or not the actual spot price of a commodity/financial asset will be versus its current higher future price. Contango is typically a condition of a bullish market, where people think prices and demand will go up in the future. Backwardation is a condition of a bearish market, where investors think prices and demand will fall in the future.
Do you already work with a financial advisor?
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 opposite of contango is backwardation, when futures prices are lower than spot prices. Futures contracts are inherently speculative, but contango and backwardation are standard market conditions because investors have different views about the future. The significant difference for investors, then, is how to trade during these conditions.
Chat với tư vấn viên
Gọi ngay