Distinguishing Futures Contango from Normal Backwardation
Summary
The document considers how a futures market can be in contango while also exhibiting normal backwardation. The key clarification is that the terms refer to different comparisons: contango describes the relationship between futures and spot prices observed now, while normal backwardation compares a futures price with the expected spot price at the contract’s expiry. Those relationships can therefore coexist without implying a contradiction about the futures price’s movement over time.
The answers also note that curve shape may vary across maturities, and point to carrying costs, storage constraints, supply cycles, and limited storage as influences on futures prices. An oil market example, including negative futures prices, is mentioned but not analyzed. The discussion is brief and does not quantify risk premia, establish a general model for the curve, or explain how either concept determines a contract’s realized price path or theta.
Key ideas
- Contango compares current futures prices with spot prices.
- Normal backwardation compares a futures price with the expected spot price at expiry.
- The two concepts use different reference prices and can coexist.
- Cost of money and storage can contribute to contango.
- Supply cycles and constrained storage can contribute to backwardation.
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Full text
# How can a future exhibit both normal backwardation and be in contango?
# How can a future exhibit both normal backwardation and be in contango?
My understanding is that "contango", when describing the forward curve, describes forward prices that are above the current spot price, i.e. $F_{t+1} > F_{t} > S$. This is directly observable at the current time.
"Normal backwardation" is the phenomenon that the current forward price is below the expected spot price at expiry. I understand this can happen when speculators go net long and expect a profit (i.e. expect a premium to take on the risk by the hedger).
However, my understanding is these two can happen simultaneously. Due to carrying costs, etc. a forward curve is often in contango. I expect this when the convenience yield is less than the cost of carry.
I would also expect that simultaneously, most futures would exhibit "normal backwardation". due to the above reasoning regarding risk premium for speculators.
My question is: how can both be true simultaneously? A forward curve in contango seems to imply to me that the future has negative theta, i.e. decays to expiry. However, normal backwardation seems to imply to me that it is positive theta, i.e. will rise to meet the spot at its (higher) expected value.
## Answer by dm63 (score 3)
https://quant.stackexchange.com/a/76576
I think these are just words. Contango means forwards are higher than spot. Backwardation means forwards are lower than spot. The only way they can both be true is if the forward curve has a complex shape so that for some forward dates , the forward is higher than spot and for others, lower.
## Answer by Alex D (score 0)
https://quant.stackexchange.com/a/76577
Yes. Especially on a stock futures/commodities market.
https://www.cmegroup.com/education/whitepapers/trading-the-curve-in-energies.html
Simply speaking, cost of money/storage causes contango and supply cycles and limit storage can cause backwardation.
A good example - negative prices on oil futures.Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.