Why does contango occur?

Last Update: April 20, 2022

This is a question our experts keep getting from time to time. Now, we have got the complete detailed explanation and answer for everyone, who is interested!

Asked by: Prof. Freeda Murazik
Score: 4.2/5 (55 votes)

Contango can be caused by several factors, including inflation expectations, expected future supply disruptions, and the carrying costs of the commodity in question. Some investors will seek to profit from contango by exploiting arbitrage opportunities between the futures and spot prices.

What causes contango and backwardation?

The opposite of backwardation is contango, where the futures contract price is higher than the expected price at some future expiration. ... 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.

Why is contango bad?

In the jargon, contango is when the futures curve slopes upwards. Contango is a problem because if you keep rolling your futures contracts in a contango market, it will whittle away any potential returns. Worse, a long contango market can undermine all the gains made from rising spot prices.

Why is contango normal?

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).

Why is contango bullish?

Contango in commodity futures

Because futures contracts are available for different months throughout the year, the price of the contracts changes from month to month. ... Contango is thus a bullish indicator, showing that the market expects the price of the futures contract to increase steadily into the future.

What are 'contango' and 'backwardation'? - MoneyWeek Investment Tutorials

27 related questions found

How do you profit from contango?

One way to benefit from contango is through arbitrage strategies. 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.

Is there still oil in contango?

It remains in contango, with the spread at minus $9 a tonne. Despite the current weakness, the spread is still far above the level of minus $92 a tonne in April 2020, when many countries entered a first round of lockdowns, and oil sellers struggled to find buyers with storage tanks brimming full.

Why is gold always in contango?

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.

Which is better contango or backwardation?

When a market is in contango, the forward price of a futures contract is higher than the spot price. Conversely, when a market is in backwardation, the forward price of the futures contract is lower than the spot price.

What is contango spread?

A contango is a situation where the futures price of a commodity is higher than the spot price. Another way for traders to profit off a contango market is to place a spread trade.

How do you deal with contango?

Consider your trading strategy. One way to trade contango is to go short or sell at spot price and then go long or buy a further out contract. This can lock in a higher sell price and a lower buy price.

Does Uvxy decay?

Due to the roll and contango effects in futures, over time the price of UVXY will decay. This means it is ill-suited to a long-term buy and hold strategy and is instead suited to very short-term bets on price volatility. Traders can also take the opposite of UVXY, which is the SVXY.

Why is there contango in Bitcoin futures?

This is somewhat unusual because in “normal” futures markets it's the reverse situation—referred to as “contango.” Contango exists in most markets because it's expected that over time prices increase (ostensibly due to inflation and other market factors).

How can you determine whether a future is in backwardation or contango 1 point?

Key Takeaways
  1. Contango is when the futures price is above the expected future spot price. ...
  2. Normal backwardation is when the futures price is below the expected future spot price. ...
  3. A futures market is normal if futures prices are higher at longer maturities and inverted if futures prices are lower at distant maturities.

What is the difference between spot price and future price known as?

The spot price of a commodity is the current cash cost of it for immediate purchase and delivery. ... The difference between the spot price and futures price in the market is called the basis.

Why do spot and futures prices converge?

Subsequently, buying the underlying asset causes an increase in the overall demand for the asset and the spot price of the underlying asset will increase as a result. As arbitragers continue to do this, the futures price and the spot price will slowly converge until they are equal, or close to equal.

What is the difference between backwardation and normal backwardation?

Backwardation: a situation where future price is low than the current spot. Normal Backwardation: a situation where future price is lower than the expected spot price. The term negative carry means backwardation.

Is VIX a contango?

The $VIX futures term structure in contango, the $VVIX Index falls over 8 points to 111 handle & @RussellRhoads breaks down Feb $VIX options trading as the Feb $VIX future remains elevated above the front month.

What is contango charge?

Contango is a situation where the futures price of a commodity is higher than the spot price. Contango usually occurs when an asset price is expected to rise over time.

Is backwardation bullish for gold?

Hence, investors can watch the backwardation in the gold market, as it may signal the imbalance between supply and demand for the yellow metal. ... In the environment of low interest rates, investors shouldn't consider it as a bullish indicator of supply shortages.

What are gold futures?

Gold futures are standardized, exchange-traded contracts in which the contract buyer agrees to take delivery, from the seller, a specific quantity of gold at a predetermined price on a future delivery date.

Is backwardation bullish for oil?

According to Gamma Point Managing Partner Rahul Rai, the backwardation is hardly a bullish sign. To wit, the condition might represent a bearish sentiment among institutions.

What is the future of oil prices?

The EIA forecast that Brent crude oil prices will average $71/b in the second half of 2021 and $66/b in 2022. Prices are increasing due to higher demand as more people are vaccinated against COVID-19. OPEC is gradually increasing oil production after limiting it due to a decreased demand for oil during the pandemic.

What exactly is the oil futures contango market?

A contango market occurs when prompt crude oil prices fall below those further out in the future. There are futures contracts for each month going out many years. These prices reflect the market's current as well as future expectations of oil prices.