What are the differences between backwardation and contango?

The major differences between backwardation and contango are as follows −

Backwardation

• It refers to the prevailing conditions of the market, when future price of commodities (gold, silver etc.) trade lower than anticipated price.

• Usually takes place when value determined (spot price – futures price) is lower than cost of carrying.

• Spot price is higher when compared to forward price of future contract in a market normal backwardation.

• Forward price of the future contract is lower as compared to spot price in a market in normal backwardation.

• Convenience yield, oversupply of futures/spot etc. are reasons for backwardation.

• Forward price curve is sloping downward (inverted market).

• Occurs rarely.

• Results a positive role in initial long futures position holders.

• Results a negative role in initial short futures position holders.

• In commodity markets, the forward price curve is sloping downwards.

Contango

• It refers to the prevailing condition of the market when the future price of commodities (gold, silver etc.) trade higher than anticipated price.

• Very common in commodities (non-perishable) and has cost of carrying.

• Spot price is lower, when compared to forward price of futures contract in a market.

• Forward price, if the future contract is relatively higher than spot price in a market.

• Oversupply of future/spot assets, rate of interest, storage costs etc. are reasons for contango

• Forward price is sloping upwards (normal market).

• Occurs frequently.

• Results in negative role in initial long future position holder.

• Results in positive role in initial short future position holder.

• In the commodity market, the price curve is upwards sloping.

Nagasravan Tamma

Updated on: 18-May-2022

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