What Basis Means
Basis is the difference between the futures price and the spot price of the same underlying asset. As a contract approaches expiration, basis typically narrows and theoretically converges to zero at expiry, since the futures and spot prices must align by then.
Contango: Futures Priced Above Spot
Contango describes a market structure where futures prices sit above the spot price, common in many commodity markets once storage and financing costs are factored in. In this structure, rolling an expiring futures contract into a new one means buying at a higher price, creating a roll cost that erodes returns over time.
Backwardation: Futures Priced Below Spot
Backwardation is the opposite, futures priced below spot, typically appearing when current supply is tight or near-term demand is unusually strong. In this structure, rolling into a new contract can actually generate roll yield, since the new contract is bought at a lower price.
Practical Implications for Investors
For investors in commodity or oil futures ETFs, whether the market is in contango or backwardation can meaningfully affect long-term returns even if the spot price stays flat, making the shape of the futures curve just as important to check as the underlying’s price outlook.
| Structure | Contango | Backwardation |
|---|---|---|
| Price relationship | Futures > Spot | Futures < Spot |
| Roll yield effect | Cost (unfavorable) | Gain (favorable) |
| Typically seen when | Storage costs dominate, normal markets | Supply shortage, strong near-term demand |
Frequently Asked Questions
Is basis always positive or always negative?
No, it shifts between contango and backwardation depending on supply and demand conditions, and even the same commodity can switch structure over time.
Do stock index futures show contango or backwardation too?
Yes, depending on dividend yields and interest rates, stock index futures can trade in either contango or backwardation, with high-dividend indices sometimes showing backwardation.
Can roll costs be avoided?
Diversifying across futures contracts with different expirations, or using spot-based products instead of heavily contango-affected futures ETFs, are strategies used to manage roll cost exposure.
What is basis trading?
Basis trading involves taking offsetting positions in futures and spot markets to profit from an expected narrowing or widening of the basis itself, a form of arbitrage strategy.
Key Takeaways
Futures basis captures the gap between futures and spot prices, and whether a market sits in contango or backwardation determines whether rolling contracts costs money or generates yield. Commodity futures ETF investors in particular should watch this structure, not just the spot price outlook. This article is for informational purposes only and does not constitute investment advice.
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