1 min read
Contango is a market phenomenon which occurs when the futures price of a commodity is higher than the spot price because the asset price is expected to rise over time. Contango can be recognized as an upward sloping forward curve.
Futures contract supply and demand for the asset affect the futures price at each expiration. In contango, investors are indicating a willingness to pay more for a commodity in the future. The premium above the current spot price for an expiration date is usually associated with the cost-of-carry, which is any charges needed to hold the asset over a period of time, and usually includes storage costs and depreciation. If the price difference ever exceeds the cost-of-carry, traders will sell their futures and buy spot, bringing the prices back into equilibrium.
In a liquid market, due to the large number of buyers and sellers in the market, the futures price will usually converge toward the spot price as the contract approaches expiration. A market in contango will see gradual decreases in the futures price to meet the spot price. Having many buyers and sellers eliminates opportunities for arbitrage and makes markets.