Contango is when the futures price of a commodity is higher than the spot price. This indicates that investors are willing to pay more for the commodity in the future. Contango is often the result of carrying costs and bullish sentiment about future prices.
Contango refers to a situation where the futures price of an underlying commodity is higher than its current spot price. Contango is considered a bullish sign because the market expects that the price of the underlying commodity will rise in the future and as such, participants are willing to pay a premium for it now.
Contango is a situation in which the futures price (or forward price) of a commodity is higher than the spot price. In a contango situation, arbitrageurs or speculators are "willing to pay more for a commodity [to be received] at some point in the future than to purchase the commodity immediately.
For example, let's say that the spot price of Brent Crude Oil today is $70 per barrel. If you buy a futures contract that expires in two months, if the holder of that contract receives their oil and has to pay $75, this means that the market is in contango.
What are 'contango' and 'backwardation'? - MoneyWeek Investment Tutorials
What is the contango for dummies?
Contango: When the futures price is higher than the expected spot price, often 1. leading to costs for the fund rolling over contracts. Backwardation: When futures prices are lower than the spot price, potentially 2. benefiting the fund during contract rollovers.
Among various approaches, trend following stands out as the most profitable trading strategy for many traders and hedge funds. The core idea is simple: “the trend is your friend.” This strategy capitalizes on sustained market moves, whether upward or downward.
Backwardation creates market inefficiencies that help traders spot price disparities between spot markets and futures contracts. These inefficiencies offer opportunities to buy spot or short-term futures while selling longer-dated contracts.
The most significant risk of contango is the negative impact on investment returns, primarily resulting from negative roll yields. This erosion of returns can significantly impact investment performance, especially for long-term holders of futures contracts or commodity ETFs.
Contango can arise due to various factors, including market expectations of future price increases, carrying costs, storage expenses, and interest rates.
Generally speaking, contango is a normal situation for durable and easily storable commodities which have a cost of carry, such as gold. This is due to the carry costs - higher futures price is a way of paying for these costs. Indeed, gold spends most of the time in contango.
This market is in contango - the futures contracts are trading at a premium to the spot price. Physically delivered futures contracts may be in a contango because of fundamental factors like storage, financing (cost to carry) and insurance costs.
Backwardation is a market condition in which the spot or current price of an underlying asset exceeds the trading prices of the futures market. It is used by traders to generate profits by selling short at the current price and purchasing at a diminished futures price.
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.
Indeed, gold spends most of the time in contango, as it's reflected by the positive gold offered forward rate. The opposite of contango is backwardation, which is much rarer in the gold market.
The firm tends to overhedge if the amount of backwardation exceeds hedging costs. The firm hedges fully if the extent of backwardation equals hedging costs. If hedging costs exceed the amount of backwardation, or, if the futures market is unbiased or exhibits contango, the optimal hedge is a partial hedge.
The primary cause of backwardation in the commodities' futures market is a shortage of the commodity in the spot market. Manipulation of supply is common in the crude oil market. For example, some countries attempt to keep oil prices at high levels to boost their revenues.
When the convenience yield is high, the futures price curve can become downward sloping, a situation known as 'backwardation'. Conversely, when the convenience yield is low, the futures price curve can become upward sloping, a situation known as 'contango'.
The leverage available through futures allows you to control a larger trading position with less capital (e.g., a smaller account size). With futures, you can often put up less than 5% of the contract value to control a position.
Futures contracts use leverage, which means a smaller initial investment gives you exposure to a larger amount of notional value. When using leverage, a small market movement can have a large impact—positive or negative—on the account's profit or loss (P/L).
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