While the word contango may sound mysterious, it is used to
describe a fairly normal pricing situation in futures. A market
is said to be in contango when the forward price of a futures
contract is above the expected future spot price. Normal
backwardation, which is essentially the opposite of contango,
occurs when the forward price of a futures contract is below the
expected future spot price. Because contango and backwardation
are known states in the market, traders can employ strategies
that attempt to exploit them. Contango and backwardation are
frequently seen in commodity markets where certain factors
prompt the price discrepancy between expected future spot prices
and the price of futures contracts. Here, we will introduce the
two market states of contango and normal backwardation, explain
why they happen and how they affect futures traders. Back to
basics A brief review of exactly what a futures contract is can
be helpful when trying to understand contango and backwardation.
A futures contract is a le