What is Contango? Definition and Meaning
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. 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. Fortunately, the loss caused by contango is limited to commodity ETFs that use futures contracts, such as oil ETFs. High-interest rates can contribute to a contango market because they increase the cost of carrying an asset, pushing up futures prices. Similarly, in the gold market, contango may arise due to storage costs and interest rates, combined with expectations of future price movements.
What are some strategies for managing Contango risk?
- When the futures price of something is higher than its present spot price, investors are willing to pay more for the commodity in the future.
- Contango is a term used in financial markets to describe a situation where the future price of a commodity or financial instrument is higher than the spot price.
- A contango market is also known as a normal market or carrying-cost market.
- This creates a downward sloping curve for futures prices over time relative to the current spot price.
The difference is normal/inverted refers to the shape using tableau for data mining and chat conversation analysis of the curve as we take a snapshot in time. Gold ETFs and other funds that hold actual commodities for investors do not typically face the problems of contango. Contango is when the futures price of an asset is higher than its current price.
A market is in contango when a commodity/financial asset’s futures prices are rising above its current spot price, creating an upward sloping price curve. This shows that investors expect the price of the commodity/financial asset to go up in the future. On the other side of the trade are speculators willing to take on the risk the hedgers will pay to avoid. Speculators earn a risk premium by committing to sell futures contracts at a price lower than the expected spot price. “The normal supply price on the spot includes remuneration for the risk of price fluctuations during the period of production while the forward price excludes this,” Keynes wrote.
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It acts as a bullish signal for traders, indicating that holding onto or entering a buy position could be a prudent decision at the current spot price. The reason behind this is that the strike price of the contract is anticipated to rise in the future. Contango is normal for a nonperishable commodity that has a cost of carry.
If a market is in a state of contango, the spot price is lower than future prices. In other words, investors are willing to pay more in the future for the commodity than what they would pay for it today. In case of physical assets such as commodities, the cost of carry mostly comprises storage costs and depreciation due to spoilage, decay or rotting.
Role of Contango in Commodity Arbitrage
Backwardation can also be the result of “convenience yield” for deliverable physical commodities, a phenomenon in which buyers decide to load up on their commodities now rather than later. 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 market. It also leads to negative rolling returns as futures prices are always higher than the spot prices resulting in rolling costs for each monthly rollover. Contango is a situation where the futures prices of a commodity are trading at a higher rate than the spot price.
When is a market in contango?
It is important to note that just Contango differs from “Normal Contango.” A Normal Contango refers to a situation in which the futures price is greater than the expected spot price. You could track commodities markets though for information to help your stock trades. For example, if oil has gone into steep contango, this could be good news for oil companies and bad news for airlines. 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. Commodities prices are set by investors buying and selling contracts for the delivery of raw materials now and in the future.
The spot price is what you would pay to take possession of the asset now, while the futures price is what bitcoin price crash wipes $10000 from its value investors are willing to pay to take delivery of an asset on specific dates in the future. Understanding these concepts is crucial for anyone involved in futures markets since they can dramatically affect returns and risk management strategies across a wide range of assets. They are also important beyond derivatives trading for what they tell us about the state of the market or economy. For example, commodities like oil and gas require expensive storage solutions, and these costs are factored into futures prices. Contango comes into play in the futures market, where buyers and sellers trade contracts for assets to be delivered at a future date. Contango is a term used in financial markets to describe a situation where the future price of a commodity or financial instrument is higher than the spot price.
The underlying issue—the bitpay card adds apple pay support excess stock—must be addressed directly for the economy to recover. Thus, there’s a straight line from Keynes’s discussion of backwardation to his renowned claims of the 1930s about the role of the government and fiscal policy to fill the demand this phenomenon shows has fallen away. The more prices drop, the less money businesses make and the less they can afford to keep producing. Eventually, they might have to cut back on production or lay off workers, worsening the economic downturn. Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance.
