Backwardation
Table of Contents
Backwardation:
Backwardation is a term used in finance to describe a situation where the future price of a commodity is lower than the current price. This is the opposite of contango, where the future price of a commodity is higher than the current price.
Backwardation can occur when there is a commodity shortage in the market, and traders expect the price to rise. It can also occur when the demand for the commodity is high, and traders expect the price to fall in the future.
What is Backwardation?
Backwardation is a market state in which future prices are lower than current prices. This condition is the opposite of contango, where future prices are higher than current prices. Backwardation can occur in markets for physical commodities, futures contracts, and other derivatives.
The cause of backwardation is typically due to an anticipated shortage in the supply of the underlying asset. For example, if there is a drought and the crop yield is expected to be lower than normal, the price of wheat futures will be in backwardation. Farmers will hold on to their wheat in anticipation of higher prices, while buyers are willing to pay a premium for wheat to secure supply.
Backwardation can also be caused by government policy. For example, if the government imposes a tax on wheat, the price of wheat futures will be backward. This is because the tax will increase the cost of wheat in the future while the present price will be lower.
In general, backwardation is considered a bullish sign for a market, as it indicates strong demand for the underlying asset.
Advantage of Backwardation
The easiest way to take advantage of a backwardation market state is to simply buy the underlying asset. This is because, in a backwardation market, the spot price is usually lower than the future price. So, by buying the asset now, you can sell it in the future at a higher price and pocket the difference.
Of course, not everyone is able to buy the underlying asset. For example, if you are a currency trader, you cannot directly buy the underlying asset (e.g. a barrel of oil). In this case, you can take advantage of the backwardation market state by selling the asset now and buying it back in the future at a lower price. This way, you will still be able to pocket the difference between the spot price and the future price.
Disadvantage of backwardation
Backwardation is when the futures price is lower than the spot price. This can be disadvantageous for investors because it indicates that the market is expecting prices to fall in the future. This can lead to investors selling their assets to avoid losses, further driving prices down.
Backwardation can also make it difficult to hedge against price movements, as investors may need to sell their assets to meet their obligations.
How do traders use backwardation?
Traders use backwardation to predict future price movements. If the market is backward, it means that the prices of futures contracts are lower than the spot price. This usually happens when the demand for a commodity is high, and the supply is low.
If traders believe that the prices of futures contracts will go up in the future, they will buy them at lower prices. This allows them to profit when the contracts’ prices increase.
Causes of backwardation
There can be a few different causes of backwardation in finance. One possibility is that it could be due to a lack of available funds. This could happen if there is a great demand for a certain asset, but not enough people are willing to sell it. This could lead to a situation where the prices of assets are rising, but there needs to be more available to meet the demand.
Another possibility is that a change in market conditions could cause backwardation. This could happen if there is a sudden increase in the demand for a certain asset, but the supply remains the same. This could lead to an asset shortage and a rise in prices.
Frequently Asked Questions
The main difference between backwardation and contango is that backwardation is when the price of a commodity is lower in the future than it is in the present, while contango is when the price of a commodity is higher in the future than it is in the present.
This difference can be due to a number of factors, including expectations about future demand and supply, and the costs of storage and transportation.
There is normal backwardation when the futures price is less than the anticipated future spot price. An inverted futures curve is frequently mistaken for a normal backwardation market.
Since contracts for later dates would often trade at even lower values, the overall futures curve would normally be downwards sloping (i.e., “inverted”). The phrase “backwardation” may relate to “positive basis,” which happens when the current spot price is higher than the future price. In practice, the predicted future spot price is uncertain.
A normal backwardation curve in finance is one where the interest rate on a forward contract is lower than the spot rate. This is because the holder of the forward contract can earn a higher rate of return by investing the money at the spot rate and then receiving the money at the forward rate.
Backwardation is an important financial concept that can be used to generate profits. By taking advantage of backwardation, investors can buy the commodity at the current price and then sell it at a higher price in the future, thus generating a profit.
Super backwardation is a term used in finance to describe a situation where the futures price of a commodity is lower than the spot price. This often happens when there is a great demand for the commodity, and traders are willing to pay a premium to get it now rather than wait for delivery in the future. Super backwardation can also be caused by a lack of supply of the commodity, which drives up the price.
Related Terms
- Cost of Equity
- Capital Adequacy Ratio (CAR)
- Interest Coverage Ratio
- Industry Groups
- Income Statement
- Historical Volatility (HV)
- Embedded Options
- Dynamic Asset Allocation
- Depositary Receipts
- Deferment Payment Option
- Debt-to-Equity Ratio
- Financial Futures
- Contingent Capital
- Conduit Issuers
- Calendar Spread
- Cost of Equity
- Capital Adequacy Ratio (CAR)
- Interest Coverage Ratio
- Industry Groups
- Income Statement
- Historical Volatility (HV)
- Embedded Options
- Dynamic Asset Allocation
- Depositary Receipts
- Deferment Payment Option
- Debt-to-Equity Ratio
- Financial Futures
- Contingent Capital
- Conduit Issuers
- Calendar Spread
- Devaluation
- Grading Certificates
- Distributable Net Income
- Cover Order
- Tracking Index
- Auction Rate Securities
- Arbitrage-Free Pricing
- Net Profits Interest
- Borrowing Limit
- Algorithmic Trading
- Corporate Action
- Spillover Effect
- Economic Forecasting
- Treynor Ratio
- Hammer Candlestick
- DuPont Analysis
- Net Profit Margin
- Law of One Price
- Annual Value
- Rollover option
- Financial Analysis
- Currency Hedging
- Lump sum payment
- Annual Percentage Yield (APY)
- Excess Equity
- Fiduciary Duty
- Bought-deal underwriting
- Anonymous Trading
- Fair Market Value
- Fixed Income Securities
- Redemption fee
- Acid Test Ratio
- Bid Ask price
- Finance Charge
- Futures
- Basis grades
- Short Covering
- Visible Supply
- Transferable notice
- Intangibles expenses
- Strong order book
- Fiat money
- Trailing Stops
- Exchange Control
- Relevant Cost
- Dow Theory
- Hyperdeflation
- Hope Credit
- Futures contracts
- Human capital
- Subrogation
- Qualifying Annuity
- Strategic Alliance
- Probate Court
- Procurement
- Holding company
- Harmonic mean
- Income protection insurance
- Recession
- Savings Ratios
- Pump and dump
- Total Debt Servicing Ratio
- Debt to Asset Ratio
- Liquid Assets to Net Worth Ratio
- Liquidity Ratio
- Personal financial ratios
- T-bills
- Payroll deduction plan
- Operating expenses
- Demand elasticity
- Deferred compensation
- Conflict theory
- Acid-test ratio
- Withholding Tax
- Benchmark index
- Double Taxation Relief
- Debtor Risk
- Securitization
- Yield on Distribution
- Currency Swap
- Overcollateralization
- Efficient Frontier
- Listing Rules
- Green Shoe Options
- Accrued Interest
- Market Order
- Accrued Expenses
- Target Leverage Ratio
- Acceptance Credit
- Balloon Interest
- Abridged Prospectus
- Data Tagging
- Perpetuity
- Optimal portfolio
- Hybrid annuity
- Investor fallout
- Intermediated market
- Information-less trades
- Back Months
- Adjusted Futures Price
- Expected maturity date
- Excess spread
- Quantitative tightening
- Accreted Value
- Equity Clawback
- Soft Dollar Broker
- Stagnation
- Replenishment
- Decoupling
- Holding period
- Regression analysis
- Wealth manager
- Financial plan
- Adequacy of coverage
- Actual market
- Credit risk
- Insurance
- Financial independence
- Annual report
- Financial management
- Ageing schedule
- Global indices
- Folio number
- Accrual basis
- Liquidity risk
- Quick Ratio
- Unearned Income
- Sustainability
- Value at Risk
- Vertical Financial Analysis
- Residual maturity
- Operating Margin
- Trust deed
- Profit and Loss Statement
- Junior Market
- Affinity fraud
- Base currency
- Working capital
- Individual Savings Account
- Redemption yield
- Net profit margin
- Fringe benefits
- Fiscal policy
- Escrow
- Externality
- Multi-level marketing
- Joint tenancy
- Liquidity coverage ratio
- Hurdle rate
- Kiddie tax
- Giffen Goods
- Keynesian economics
- EBITA
- Risk Tolerance
- Disbursement
- Bayes’ Theorem
- Amalgamation
- Adverse selection
- Contribution Margin
- Accounting Equation
- Value chain
- Gross Income
- Net present value
- Liability
- Leverage ratio
- Inventory turnover
- Gross margin
- Collateral
- Being Bearish
- Being Bullish
- Commodity
- Exchange rate
- Basis point
- Inception date
- Riskometer
- Trigger Option
- Zeta model
- Racketeering
- Market Indexes
- Short Selling
- Quartile rank
- Defeasance
- Cut-off-time
- Business-to-Consumer
- Bankruptcy
- Acquisition
- Turnover Ratio
- Indexation
- Fiduciary responsibility
- Benchmark
- Pegging
- Illiquidity
- Backup Withholding
- Buyout
- Beneficial owner
- Contingent deferred sales charge
- Exchange privilege
- Asset allocation
- Maturity distribution
- Letter of Intent
- Emerging Markets
- Cash Settlement
- Cash Flow
- Capital Lease Obligations
- Book-to-Bill-Ratio
- Capital Gains or Losses
- Balance Sheet
- Capital Lease
Most Popular Terms
Other Terms
- Protective Put
- Perpetual Bond
- Option Adjusted Spread (OAS)
- Non-Diversifiable Risk
- Merger Arbitrage
- Liability-Driven Investment (LDI)
- Income Bonds
- Guaranteed Investment Contract (GIC)
- Flash Crash
- Equity Carve-Outs
- Cost Basis
- Deferred Annuity
- Cash-on-Cash Return
- Earning Surprise
- Bubble
- Beta Risk
- Bear Spread
- Asset Play
- Accrued Market Discount
- Ladder Strategy
- Junk Status
- Intrinsic Value of Stock
- Interest-Only Bonds (IO)
- Inflation Hedge
- Incremental Yield
- Industrial Bonds
- Holding Period Return
- Hedge Effectiveness
- Flat Yield Curve
- Fallen Angel
- Exotic Options
- Execution Risk
- Exchange-Traded Notes
- Event-Driven Strategy
- Eurodollar Bonds
- Enhanced Index Fund
- EBITDA Margin
- Dual-Currency Bond
- Downside Capture Ratio
- Dollar Rolls
- Dividend Declaration Date
- Dividend Capture Strategy
- Distribution Yield
- Delta Neutral
- Derivative Security
- Dark Pools
- Death Cross
- Fixed-to-floating rate bonds
- First Call Date
- Firm Order
Know More about
Tools/Educational Resources
Markets Offered by POEMS
Read the Latest Market Journal
Recognising Biases in Investing and Tips to Avoid Them
Common biases like overconfidence, herd mentality, and loss aversion influence both risk assessment and decision-making....
What is Money Dysmorphia and How to Overcome it?
Money dysmorphia happens when the way you feel about your finances doesn’t match the reality...
The Employer’s Guide to Domestic Helper Insurance
Domestic Helper insurance may appear to be just another compliance task for employers in Singapore,...
One Stock, Many Prices: Understanding US Markets
Why Isn’t My Order Filled at the Price I See? Have you ever set a...
Why Every Investor Should Understand Put Selling
Introduction Options trading can seem complicated at first, but it offers investors flexible strategies to...
Mastering Stop-Loss Placement: A Guide to Profitability in Forex Trading
Effective stop-loss placement is a cornerstone of prudent risk management in forex trading. It’s not...
Boosting ETF Portfolio Efficiency: Reducing Tax Leakage Through Smarter ETF Selection
Introduction: Why Tax Efficiency Matters in Global ETF Investing Diversification is the foundation of a...
How to Build a Diversified Global ETF Portfolio
Introduction: Why Diversification Is Essential in 2025 In our June edition article (https://www.poems.com.sg/market-journal/the-complete-etf-playbook-for-singapore-investors-from-beginner-to-advanced-strategies/), we introduced...
