Glossary · Funds and derivatives
Contango and backwardation
Contango is when futures for later delivery cost more than for sooner delivery; backwardation is the opposite, with later delivery cheaper.
Also called: contango, backwardation, futures curve, roll yield
In plain words
Oil for delivery today, in three months and in a year can all have different prices. Line them up and you get the futures curve. When later delivery costs more, so the curve slopes up, the market is in contango. When later delivery costs less, so it slopes down, it is in backwardation.
Contango is the normal state for things you can store. Someone who buys oil today and keeps it for a year has to pay for the tank, the insurance and the money tied up, so oil for delivery in a year should cost about that much more.
Backwardation usually means a shortage now: buyers pay extra to get the stuff immediately, and having it on hand (the convenience yield) is worth more than the cost of storing it.
Example
Why a fund can lose while the price stands still
An oil fund holds the nearest futures contract and must roll it before delivery: sell the expiring one and buy the next. Say oil stays at $70 all year, and each next-month contract costs 1% more (contango).
- Month 1: the fund sells its expiring contract at $70 and buys next month’s at $70.70. Its money buys 1% fewer barrels.
- By expiry the new contract has fallen back to $70, the spot price, so the fund is about 1% behind.
- Repeat every month: after a year it holds 1 ÷ 1.0112 ≈ 0.887 of what it started with: about 11% less, while the oil price did not move.
- In backwardation it works the other way: each roll buys more barrels, and the fund gains even with a flat price.
This roll yield is why funds that hold futures can end far from the price of the commodity itself.
One level deeper
In theory, futures price ≈ spot price + storage and financing costs − the convenience of holding the goods now. Things that cost little to store but are scarce, like oil in a supply crisis, can swing into steep backwardation; things in glut swing into steep contango.
In April 2020, oil was in “super contango”: storage was so full that oil for delivery months later cost far more than oil for delivery right away, and the expiring contract briefly went below zero (see futures).
The words also describe other futures curves. VIX futures are usually in contango, because markets expect calm periods to give way to storms; funds that hold them roll into dearer contracts month after month, which is why most long-volatility funds have lost value over time.
Why it matters
The shape of the curve tells you whether the market sees a shortage now or plenty.
It decides how much a futures-based commodity fund gains or loses beyond the price itself, through the roll.
Traders with storage can earn from contango: buy now, sell for later delivery at a higher price, and keep the oil in tanks or ships.
A common mistake
Myth: Contango means traders expect the price to rise.
In fact: Not necessarily. In contango the later price mostly reflects the cost of storing and financing the goods until then, not a forecast. Spot prices often stay flat or fall while the curve sits in contango.
Questions people ask
Is contango bullish or bearish?
Neither on its own. Steep contango often means too much supply right now, which is a sign of weakness in the present market; backwardation often means tight supply. The future price is not a reliable forecast either way.
Why does contango hurt commodity ETFs?
Funds that hold futures must keep selling the expiring contract and buying a later, dearer one. In contango each roll buys fewer units, so the fund falls behind the spot price, even if that price does not move.
Where do the words come from?
Both come from the 19th-century London Stock Exchange, where contango was a fee paid to delay settling a trade and backwardation a fee in the other direction.
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About the numbers
- This page explains a term. It is not investment advice.