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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.
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.
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.
MANAGEMENT
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.
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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.
What is Contango?
As such, a market in contango will see gradual decreases in the price to meet the spot price at expiration. 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. 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).
Contango is a unique decentralized market offering expirables, contracts to buy or sell an asset at a set price and date in the future. When a trader opens a position, the protocol borrows on the fixed-rate market, swaps on the spot market, then lends back on the fixed-rate market. Contango offers physical delivery and a minimal price impact for larger trades.
- The old Cantango got too bloated and big and became too hard to maintain in the end.
- Spot PriceA spot price is the current market price of a commodity, financial product, or derivative product, and it is the price at which an investor or trader can buy or sell an asset or security for immediate delivery.
- It may be signaling that investors are expecting asset prices to fall over time.
- Contango is normal for a non-perishable commodity that has a cost of carry.
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Pros and cons of contango
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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.
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If such was the case, the premium may have ended when global oil storage capacity became exhausted; the contango would have deepened as the lack of storage supply to soak up excess oil supply would have put further pressure on spot prices. However, as crude and gasoline prices continued to rise between 2007 and 2008 this practice became so contentious that in June 2008 the Commodity Futures Trading Commission, the Federal Reserve, and the U.S. Securities and Exchange Commission decided to create task forces to investigate whether this took place. Spot PriceA spot price is the current market price of a commodity, financial product, or derivative product, and it is the price at which an investor or trader can buy or sell an asset or security for immediate delivery. Contango is normal for a non-perishable commodity that has a cost of carry. Such costs include warehousing fees and interest forgone on money tied up (or the time-value-of money, etc.), less income from leasing out the commodity if possible (e.g. gold).
GAS
Contango is considered to be a bullish sign – the wider markets expect the price of the underlying commodity to increase in the future. Our vision is to be recognized as a leading profitable producer of oil and natural gas. We will distinguish ourselves from our competitors by employing strong technical leadership and creative commercial solutions, along with the desire to successfully explore for oil and gas as the low cost producer. 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. The spot price is the price at which an asset can be bought or sold for immediate delivery of that asset. In this scenario, the trader would make a profit of $10 on each barrel of oil while storing the physical oil for a few months.
Contango usually occurs when an asset price is expected to rise over time. A disadvantage of contango would be the automatic rolling forward of contracts, which can lead traders to incur losses when a futures contract lmfx review expires at a higher price than the spot price of the commodity. As we approach contract maturity—we might be long or short the futures contract—the futures price must move or converge toward the spot price.
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Contango Meaning, Why It Happens, and Backwardation
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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.
What is the opposite of contango?
Thus there is a positive role return when the market is in backwardation. CommoditiesA commodity refers to a good convertible into another product or service of more value through trade and commerce activities. It serves as an input or raw material for the manufacturing and production units. In a June 2010 article in The Economist, the argument is made that index-tracking funds did not cause the bubble. It describes a report by the Organisation for Economic Co-operation and Development that used data from the Commodity Futures Trading Commission to make the case.
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 is paxful legit 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.