Business

Nine Markets in Contango And Backwardation [CHARTS]

At the beginning of the year, we came out with some serious and some not so serious suggestions to play the Crude Oil inevitable rebound, and one of them included buying a contract 12 to 18 months out instead of trying the ever so popular oil ETF $USO.

The ideas of contracts at different months with different prices, expiring on different days is something our equity market friends aren’t that familiar with. Let’s take Crude Oil for instance. For example, if one was to buy an April 2015 contract, it would be priced at 49.28, compared to a contract set to expire in September of 2015 priced at 58.00. For a more visual display of such a difference, here’s the price difference of contracts every 6 months (March ’15, September ’15, February 2016, and July ’16). For the most part the contracts trade at the same level until these become the front month contract, and in so, become the most liquid contract to trade.

Crude Oil 6 months Contango

(Disclaimer: Past performance is not necessarily indicative of future results)
Chart Courtesy: Barchart

This is just one of many ways to chart the differences in prices of contracts by month. Charting out the price difference by months chronologically would display what’s called a “price curve.” This curve is actually incredibly important to some managed futures strategies because some of their strategies are based solely if a market’s price is higher or lower in the further out months. We in the biz like to use the phrases Backwardation and Contango. Back in 2013, we went into detail on the definitions of the two, but the Sparknotes version is that a downward sloping price curve (further out prices are lower than current/nearer prices) is called backwardation and that an upward sloping curve where prices are higher and higher the further out in time you go is called Contango.

Simple enough. But here’s where things get a little tricky. If the market is in Contango, the investors in ETFs following that market typically see underperformance from that market structure itself. This is because the ETF has to pay the roll yield, which means they have to sell the contract before it expires at the lower price and buy the further out contract at a higher price. Last year we looked at which markets are in Backwardation and Contango, and here’s an update:

Markets in Contango:

Crude

(Disclaimer: Past performance is not necessarily indicative of future results)

Coffee(Disclaimer: Past performance is not necessarily indicative of future results)

US Dollar(Disclaimer: Past performance is not necessarily indicative of future results)

Corn(Disclaimer: Past performance is not necessarily indicative of future results)

Wheat(Disclaimer: Past performance is not necessarily indicative of future results)

Markets in Backwardation:

Emini SP(Disclaimer: Past performance is not necessarily indicative of future results)

10yr note(Disclaimer: Past performance is not necessarily indicative of future results)

Mixed Markets:

Gold(Disclaimer: Past performance is not necessarily indicative of future results)

Lean Hogs(Disclaimer: Past performance is not necessarily indicative of future results)