Backwardation
Quick Definition
A market condition where the futures price of a commodity is lower than the current spot price, often signaling tight supply.
What Is Backwardation?
Backwardation occurs when futures contracts trade at progressively lower prices for later delivery dates compared to the current spot price. This creates a downward-sloping futures curve. Backwardation typically signals that current supply is tight relative to demand, making immediate delivery more valuable than future delivery. It is common in commodity markets during supply disruptions, seasonal shortages, or high immediate demand. For investors who roll futures contracts, backwardation generates a positive "roll yield" because they sell expiring contracts at higher prices and buy later-dated contracts at lower prices. This is the opposite of contango, where futures prices exceed spot prices.
Backwardation Example
- 1During an oil supply disruption, crude oil spot price is $85/barrel while the 6-month futures contract trades at $78 — the market is in backwardation
- 2A commodity ETF benefits from backwardation because it earns positive roll yield when replacing expiring contracts with cheaper longer-dated ones
Related Terms
Contango
A market condition where futures prices are higher than the current spot price, typically reflecting storage costs, financing costs, and convenience yield.
Futures Contract
A standardized exchange-traded agreement to buy or sell an asset at a predetermined price on a specific future date, with daily mark-to-market settlement.
Forward Contract
A customized private agreement between two parties to buy or sell an asset at a specified price on a future date, traded over-the-counter.
Mark to Market
The practice of valuing positions at current market prices and settling daily gains/losses, standard in futures markets and portfolio accounting.
Call Option
A contract giving the holder the right, but not the obligation, to buy an underlying asset at a specified price within a specified time period.
Put Option
A contract giving the holder the right, but not the obligation, to sell an underlying asset at a specified price within a specified time period.
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