In contango and backwardation, we are talking about the forward curve of futures. Futures, as we know, do not all have the same price. The price table above shows the price of crude oil futures for the coming months. As you can see the price of oil is getting cheaper every month. This is because in the last few months, the price of oil has risen very sharply.
A year ago, the December 2021 CL Future was trading at less than $40 and today it is around $84. The future with the shortest maturity moves the most during strong price movements, while the future with the longest maturity moves the least. The closer the expiration date, the closer the spot price and the futures price move.
This creates a curve. If the curve moves upwards, we talk about contango, if it moves downwards, we talk about backwardation.
What is Contango?
Contango always occurs when a financial product has fallen sharply in price. Then the spot price is significantly lower than the futures price. Anyone investing in futures for the long term should always keep an eye on the forward curve. Contango can cause drastic losses over time. This is because on the expiration date of the futures, the more expensive one of the new month has to be bought. There are ETFs that invest exclusively in futures that are often in contango. These ETFs continuously lose their value. This occurs very strongly with volatility ETFs, such as the VXX:
What is backwardation?
Backwardation is exactly the opposite of contango. The price list with oil futures shows a lower value from month to month. This means that oil is currently in backwardation. An ETF that invests in oil futures currently gets the futures a little cheaper each new month, which has caused the value of the ETF to also increase sharply in value: