Contango and Backwardation

Contango is the word which is often used in future markets, and it can be defined as a situation where the future price of any commodity or stock is higher than the current market price or spot price of that commodity or stock. This kind of market is featured by progressively rising future price as the time to delivery becomes more distant, so for example in January the price of February futures of a stock or commodity will be higher than January and price of March futures of same stock or commodity will be higher than February futures.

While Backwardation is exact opposite of Contango, under this type of markets the future prices are lower than cash price and also progressively declining price as the time to delivery becomes distant.

From the above one can see that Contango is a normal market condition which takes into account time value of money while backwardation rarely happens in equity or commodities market because in case of backwardation people will rather buy a stock or commodity in future market and take advantage of time factor than purchasing the same in the spot market.

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