Backwardation

Backwardation is a market phenomenon which occurs when the spot price of an underlying asset is higher than prices trading in the futures market. Backwardation can occur as a result of a higher short-term demand for an asset relative to the demand for contracts maturing in the futures market. Traders use backwardation to make a profit by selling at the current, higher price and buying at the lower futures price, bringing the market back to equilibrium.

The primary cause of backwardation is a shortage of the commodity in the spot market. The opposite of backwardation is contango, where the futures price is higher than the expected price at a future expiration. Backwardation, and particularly the slope of the futures curve, indicates market sentiment that the current price is too high and the spot price will fall in the future. When futures contracts have lower prices than the spot price, traders will sell the asset at its spot price and buy the futures contracts for a profit, causing the expected spot price to lower over time and converge with the futures price.