What is Backwardation and Contango in Futures Markets?
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- เผยแพร่เมื่อ 27 ต.ค. 2024
- What is Backwardation and Contango in Futures Markets?
These classes are all based on the book Trading and Pricing Financial Derivatives, available on Amazon at this link. amzn.to/2WIoAL0
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Contango and backwardation are terms often used within commodity circles. These terms refer to the shape of the futures curve of a commodity such as gold, silver, wheat or crude oil. A futures curve can be plotted on a chart of a particular contract by using an X and Y axis. The X axis contains the various contract expiration dates while the Y axis contains the corresponding futures prices. A normal futures curve will show a rising slope as the prices of futures contracts rises in time. An inverted futures curve will show a falling slope as the prices of futures contracts falls over time.
A contango market simply means that the futures contracts are trading at a premium to the spot price. For example, if the price of a crude oil contract today is $100 per barrel, but the price for delivery in six months is $110 per barrel, that market would be in contango. On the other hand, if crude oil is trading at $100 per barrel for delivery right now, and the six month contract is trading at $95 per barrel, then that market would be said to be in backwardation.
Contango and backwardation are curve structures seen in futures markets based on several factors. It is important to remember that the futures price eventually converges on the spot price. In other words, any gaps between the futures price and the spot price will close as contract expiration nears.
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. In 1993, the German company Metallgesellschaft famously lost more than $1 billion dollars, mostly because management deployed a hedging system that profited from normal backwardation markets but did not anticipate a shift to contango markets.
Very short and concise. The series may be be even more helpful if illustrated with an example or two of futures that usually trade in contango or backwardation.
Very useful and easy to understand, thanks!
Thanks Mr Pat.
I'm in a tango with an oily contango and need an exit plan!
I think I get it now. An interesting example of a market flipping was oil earlier this year where it became cheaper to buy oil on the spot market and store it on a tanker, then sell a futures contract. From what I read this was flipping the market from its normal state of backwardation to contango. Does that sound about right?
Exactly. That example was a great illustration, in fact I made a video about it at the time. th-cam.com/video/dfqmjSOD7pQ/w-d-xo.html
Hi Will, normal backwardation refers to an inverted (downward) sloping future's/forward's curve. The normal future's curve is in contango where prices of the further-out futures are higher than the nearer expiration futures resulting in an upward sloping curve. I am saying this because you wrote that ".....flipping the market from ITS NORMAL STATE OF BACKWARDATION to contango". You or @Patrick Boyle can correct me if I am wrong. Regards.
Thank you sir!
Great video and I'm reading derivatives for thd trading floor.
One question: In that book fig 2.2. You refer to the "expected future spot price". Is this the expected spot price of the underlying (at time in the future).
Thanks.
Very helpful, thanks!
Thanks, glad you find these helpful.
What's your opinion on contango and backwardation? Do you agree with Keynes?
Please make a video on natural gas prices
would have expected a bit more from a finance professor
Any chance your book will ever come back into print?
just get Hulls book - same essence, more technical details (but still less than an MFE). It's an industry standard bible.