What Are Contango and Backwardation?
Contango and backwardation describe the two basic shapes a futures curve can take when comparing prices for contracts with different expiration dates. In contango, futures prices are higher than the current spot price and increase with longer maturities. In backwardation, futures prices are lower than the spot price and decrease with longer maturities.
Why Futures Curves Take These Shapes
What Drives Contango
Contango typically reflects the cost of carry — the expenses of storing a physical commodity, insuring it, and financing its purchase until delivery. Since holding a commodity for later delivery costs money, futures contracts for later delivery are usually priced higher than spot.
What Drives Backwardation
Backwardation often occurs when there is a near-term supply shortage or strong immediate demand, giving physical holders a “convenience yield” — a benefit from having the commodity on hand right now — that pushes near-term prices above longer-dated futures prices.
A Worked Example
Suppose crude oil’s spot price is $70 per barrel. In a contango market, the 1-month futures contract might trade at $71, the 3-month at $73, and the 6-month at $76 — each successive contract priced higher. In a backwardation market, the same contracts might instead trade at $69, $67, and $64 — each successive contract priced lower.
Contango, Backwardation, and Roll Yield
Investors who hold futures contracts rather than the physical commodity must periodically “roll” their position — selling the expiring contract and buying a longer-dated one. In contango, this means selling a cheaper contract and buying a more expensive one, creating a cost known as negative roll yield. In backwardation, the opposite happens, generating a positive roll yield.
| Aspect | Contango | Backwardation |
|---|---|---|
| Curve shape | Upward sloping (futures > spot) | Downward sloping (futures < spot) |
| Typical cause | Storage, insurance, financing costs | Near-term supply shortage, convenience yield |
| Roll yield | Negative (cost to roll forward) | Positive (gain from rolling forward) |
| Common in | Normal markets for storable commodities | Tight supply or high near-term demand |
Why This Matters for Investors
Many commodity-linked ETFs and index funds hold futures rather than physical commodities, so their long-term performance can differ meaningfully from the spot price of the underlying commodity, especially during extended periods of contango. Investors considering these products should understand the current shape of the relevant futures curve and how roll yield might affect returns.
Frequently Asked Questions
What is roll yield and why does it matter?
Roll yield is the gain or loss from replacing an expiring futures contract with a longer-dated one; in contango this is typically negative because the new contract costs more, while in backwardation it is typically positive because the new contract costs less.
Why do commodity ETFs sometimes underperform the spot price?
Many commodity ETFs hold futures contracts rather than the physical commodity, so if the market is in persistent contango, the fund incurs a negative roll yield each time it rolls contracts forward, causing the ETF’s return to lag the change in the spot price over time.
What typically causes backwardation?
Backwardation often occurs when there is a near-term supply shortage or strong immediate demand for the physical commodity, giving holders of the physical asset a “convenience yield” that makes near-term contracts more valuable than longer-dated ones.
Does contango or backwardation apply to all futures markets?
No, the shape of the futures curve can vary by commodity and by time — the same market can shift between contango and backwardation depending on current supply and demand conditions, storage costs, and interest rates.
Key Takeaways
Contango and backwardation describe the shape of the futures curve relative to the spot price, and this shape directly affects the roll yield investors experience when holding futures-based positions over time. Understanding which environment a market is in helps explain why futures-linked ETFs and funds can perform differently from the underlying spot price. This article is for informational purposes only and does not constitute investment advice.
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