While the word contango may sound mysterious, it is used to describe a fairly normal pricing situation in futures. A market is said to be in contango when the forward price of a futures contract is above the trading system forex 2013 calendar future spot price.
Normal backwardation, which is essentially the opposite of contango, occurs when the forward price of a futures contract is below the expected future spot price. Contango and backwardation are frequently seen in commodity markets where certain factors prompt the price discrepancy between expected future spot prices and the price of futures contracts. Here, we will introduce the two market states of contango and normal backwardation, explain why they happen and how they affect futures traders. A brief review of exactly what a futures contract is can be helpful when trying to understand contango and backwardation. A futures contract is a legally binding agreement to buy or sell a specified financial instrument or physical commodity at a predetermined price in the future.
Some futures contracts are settled in cash, while others call for physical delivery. Commodities are bought and sold on two separate but associated markets: The cash market, which involves the buying and selling of physical commodities, and the futures market, which involves the buying and selling of a future obligation. In a futures market, on the other hand, any exchange between the buyer and seller takes place at some predetermined time in the future. Few contracts result in physical delivery because most are closed with offsetting positions before expiration.
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