What are Contango and Backwardation?

Definition

Contango refers to a situation in the futures market where the futures price of a commodity or financial instrument is higher than the spot price. It implies that investors are willing to pay a premium for the convenience of holding the asset in the future. This situation often occurs when there are storage costs, financing costs, or other expenses associated with holding the asset until the futures contract's expiration.

Backwardation, on the other hand, is the opposite of contango. It occurs when the futures price is lower than the spot price, indicating that investors are willing to accept a discount for immediate delivery. Backwardation may suggest market expectations of supply shortages or other factors that lead to a higher spot price relative to the futures price.

In summary, contango and backwardation reflect the relationship between futures prices and spot prices, providing insights into market sentiment, supply and demand dynamics, and investor expectations.