Contango vs Backwardation: What the Shape of the Futures Curve Means

Contango and backwardation describe the direction a futures market's prices run as you look further out in time. In contango, each successive delivery month is priced higher than the month in front of it; in backwardation the distant months are priced progressively lower, so the contract closest to expiry is the expensive one. Both are definitions in the CFTC's glossary, and both describe the arrangement of prices as it stands right now across the listed months of one contract. What that arrangement implies about prices later is a separate question, and the section on prediction below takes it up.

What is contango, and what is backwardation?

Contango, as the CFTC's glossary has it, is the market where each delivery month after the nearest one is dearer than the last, step by step out along the listed months. Backwardation is that arrangement reversed: the glossary describes futures prices falling away, month by month, into the distant deliveries. The glossary illustrates the second one with gold: a January quotation of $360.00 an ounce against $355.00 for June is a backwardation of $5.00 an ounce over those five months.

A few of the surrounding glossary terms make the rest of the topic readable. The front month is the nearby month, the nearest of the contract months anyone is actually trading; the nearby delivery month is defined as whichever is closest to maturity, also called the lead month; back months are everything else, also called deferred months; and the spot month is whichever contract reaches maturity and can be delivered during the current month. Backwardation also travels under the name inverted market, defined as one where the nearer months sell at higher prices than the more distant ones, a condition the glossary associates with supply shortages and calls a market of "inverse carrying charges." Contango carries a second name as well — the glossary lists forwardation and points it straight back to the contango entry.

The price gap itself is traded directly. A calendar spread, in the glossary's first sense, is a position that buys one delivery month and sells another month of that very same contract at the same time. Switch is its word for offsetting the month you hold and opening a similar position in a different one, and it notes that this is what the trade calls rolling forward.

Why would a later delivery month cost more than the nearby one?

Because somebody has to own the commodity in the meantime, and that costs money. The glossary's entry for carrying charges, which it equates with cost of carry, is about what it takes to keep a physical commodity in a tank or a warehouse, or to hold a financial instrument, across a stretch of time; the components it names are insurance, storage and the interest on the money put up, plus other incidental costs. It also supplies the label for the upward-sloping case. Once every successive maturity is priced above the one before it, the glossary calls that a carrying charge market, and where the charge is big enough to reimburse whoever is doing the holding, it calls that a "full charge".

The EIA's Today in Energy description of the oil curve adds the same idea from the market's side. Writing about the WTI curve in 2013, it attributes the tendency for later months to price above nearer ones to the cost of storing oil, the opportunity cost of holding a long-dated position, and general uncertainty, with the front month instead reflecting near-term supply, demand and transportation conditions and the deferred contracts standing in for longer-run expectations.

Carry is not always a cost. For financial instruments the glossary splits the idea in two: negative carry is financing cost above the instrument's current return, and positive carry is financing cost below it. A contract whose underlying throws off enough return to beat the financing charge is not in the same position as a barrel of oil sitting in a tank, and the glossary's definitions do not say which way any particular market's months are arranged — that is something you read off the screen rather than deduce.

What makes a market flip into backwardation?

A shortage of the commodity now, relative to later. The EIA's page on the role of inventories describes the link plainly: as the deferred months gain ground on today's spot price, the incentive to put oil into storage and sell it later strengthens, while production that falls away abruptly, or consumption that climbs when nobody expected it to, lifts spot prices against futures and encourages stocks to be run down instead. A build in storage that market participants can see points the other way, to production outrunning consumption at the price then prevailing. Inventories are, in the EIA's framing, where supply and demand get balanced, and it treats stock levels and price spreads as signals between traders positioned for now and those carrying longer-term exposure.

The 2013 WTI episode the EIA wrote up is a worked example of the inverted case. Over roughly six months to September 2013, the front-month WTI price rose while contracts further out stayed comparatively flat, producing a steeply backwardated curve. Among the factors the EIA listed were unresolved pipeline bottlenecks moving crude out of the storage hub at Cushing, Oklahoma, high seasonal refinery demand, geopolitical events and supply disruptions, and an expectation of rising output from tight formations — its Short-Term Energy Outlook at the time projected US crude production averaging 8.4 million barrels a day in 2014, 1.9 million more than in 2012. Near-term tightness lifted the nearby contract; expectations of future supply held the back months down.

How extreme can the nearby month get when storage runs out?

Far enough to go below zero. On 20 April 2020 the front-month NYMEX WTI contract printed negative prices — a first in that contract since it began trading in 1983 — and reached -$40.32 a barrel at around 2:30 p.m. Eastern by the EIA's account, still below zero during part of the next session. The EIA's explanation is a storage story: anyone still holding at expiry has to deliver crude at Cushing or take it in, absent an arrangement made beforehand, and as of 17 April Cushing held 60 million barrels against working storage capacity of 76 million, about 2 million of it in transit and 58 million sitting in tank farms, which the EIA put at 76% full — with some of the space that was not full already committed to somebody else.

Two details are worth keeping. First, the dislocation was specific to the expiring contract: longer-dated WTI prices stayed positive, and the June Brent contract closed at $19.33 a barrel on 21 April. Second, physical delivery is the rare outcome even so — in the same article the EIA puts the share of futures traded that goes to physical delivery at about 1%. The rest is closed or rolled beforehand, the alternative to holding a futures contract until expiration. A curve can be steep because storage is scarce, and the steepness is then a fact about tank space rather than a view on oil.

Does the shape of the curve predict where the price is going?

Not in the way the wording suggests, and the ambiguity is old enough to have two separate definitions attached to it. Gorton and Rouwenhorst, in NBER Working Paper 10595, separate the trade's use of the word from the economists': traders call a market backwardated when the futures price sits below the current spot price and in contango when it sits above, whereas the theory of normal backwardation set out by Keynes in 1930 and Hicks in 1939 measures the futures price against the spot price expected to prevail later, a figure nobody can observe at the moment the futures price is agreed. Their paper points out that a commodity can be in contango on the first definition and in normal backwardation on the second at the same time, and gives the arithmetic: spot at 30, an expected future spot of 34, and a futures price agreed at 32.

What does the slope of the futures curve say about risk premiums?

It carries information about them, mixed in with an expectation and not separable by eye. Gorton and Rouwenhorst make the reason explicit: the basis is, by construction, the expected change in the spot price plus the risk premium buyers of futures expect to earn, so a change in slope can come from either — which is why the EIA, writing up the 2013 curve, could gloss backwardation in passing as prices being expected to fall. Their paper sorts every available commodity futures market each month by its basis into two equally weighted halves, rebalancing monthly from July 1959 to December 2004, and reports the high-basis half beating the low-basis half by about 10 percentage points a year in annualised terms, with a t-statistic of 5.15 on the difference and the high-basis half ahead of both the equally weighted index and the low-basis half in three months out of five on average. The authors' own conclusion is modest: the basis appears to carry information about a single commodity's risk premium, and unpicking why is left for later work. That is a study of monthly, diversified, long-and-short positioning across many markets over 45 years. It is not a rule for a day, and nothing in it says which way the next tick goes.

Does the curve matter if you only day trade a funded account?

Directly, no — on a simulated funded account traded intraday you are never in a position long enough to pay or collect carry. Our trading hours rule requires every position to be closed by 4:45 p.m. Eastern each trading day, with anything still open closed automatically and the result counted toward your balance and your drawdown. A trader who is flat every afternoon never holds a contract into a delivery month, so the slope is not a cost line in the account.

What does reach you is the price level difference between two contract months. Sierra Chart's documentation traces the difference from one month to the next to the cost of carry, interest rates included, so the quote in front of you can step to a new level when you move across — which is why the dates a contract rolls belong in your calendar rather than in a footnote. A back-adjusted continuous chart has that step edited out. The same documentation describes back adjustment as shifting the earlier months up or down by their price difference against the following month, leaving the most recent month alone and adding the amount to each bar's open, high, low and close. Its worked example prints two S&P 500 mini contracts settling on 9 March 2022 at 4275.25 and 4266.75, a difference of -8.5 applied to the earlier of the pair. The page says plainly that such a chart will not match an unadjusted one, or one that a different service adjusted by another method.

That is what curve shape amounts to for an intraday trader on any of the contracts in our instrument list: a level read off a back-adjusted chart from last spring was not a level that traded, and the gaps between contract months are where the difference came from.

FAQ

Is contango bullish or bearish?

Neither by definition. The CFTC defines contango by the arrangement of prices alone — each successive delivery month above the nearest — and the glossary attaches the cost of carry to that shape, meaning storage, insurance and interest on funds, rather than a direction. Reading the slope as a forecast is a separate step, and not a settled one: the EIA, writing about the 2013 WTI curve, glossed backwardation as prices being expected to fall, while Gorton and Rouwenhorst treat the slope as expectations and a risk premium mixed together and note that a market can be in contango on the trade's definition while in normal backwardation on Keynes's.

How do I tell whether a market is in contango right now?

Compare the listed contract months of the same product against each other, front month first. If each later month prices above the one before it, that is the arrangement the CFTC calls contango, or a carrying charge market; if the nearby is the dearest and prices fall away into the deferred months, that is backwardation, which the glossary also calls an inverted market. The difference between two months is itself tradeable as a calendar spread, per the glossary's definition.

Does the curve tell you anything about physical supply?

There is evidence that it does, in one market at one location. An EIA working paper of March 2012 by Ederington, Fernando, Holland and Lee found that from 2004 to 2011, Cushing crude oil inventories rose with the lagged spread between the two-month and one-month NYMEX WTI futures. The paper also reports that spreads over the preceding eight weeks or so appear to shape the inventory level you see today. Take Cushing out and that relationship goes: over the same years neither total US non-SPR stocks nor those of the district containing Cushing were significantly related to the spread.

Do I pay contango when I roll a futures position?

Not as a fee. Rolling, which the CFTC glossary also calls a switch, means offsetting the month you hold and opening a similar position in another, and each leg is its own transaction in its own delivery month — so the gap between the months turns up in those fills rather than as a separate charge. Trading here, the question rarely arises: our rules close every position by 4:45 p.m. Eastern.