Backwardation
Updated on July 18, 2023
Backwardation occurs in commodity markets when the current spot price of a commodity or contracts maturing earlier is higher than the price of a particular futures contract. This situation implies that the futures contract is trading at a discount compared to the spot price.
Understanding Backwardation further
Backwardation suggests that the futures contract is trading at a discount compared to the spot price, indicating an expectation of a decline in the commodity’s value over time. it can arise due to market expectations of increased demand, reduced supply, or concerns about the commodity’s availability in the future.
Backwardation motivates market participants to buy the commodity in the spot market rather than entering into a futures contract, driven by factors such as immediate need, anticipation of price decreases, or cost avoidance. It can also incentivize producers or holders of the commodity to sell their inventories immediately rather than storing them for future delivery, and traders can engage in arbitrage strategies to benefit from price differences.
The term backwardation is often associated with tight supply, strong current demand, or concerns about future availability, reflecting a sense of urgency in the market. Furthermore, backwardation is the opposite of contango, which occurs when the future price of a commodity is higher than the spot price, suggesting an expectation of a price increase over time.
