Backwardation

Loading the player...

What is 'Backwardation'

Backwardation is a theory developed in respect to the price of a futures contract and the contract's time to expire. Backwardation says that as the contract approaches expiration, the futures contract will trade at a higher price compared to when the contract was further away from expiration. This is said to occur due to the convenience yield being higher than the prevailing risk free rate.

BREAKING DOWN 'Backwardation'

When backwardation does occur in a futures market it has been suggested that an individual in the short position would benefit the most by delivering as late as possible.

Backwardation in futures contracts was called "normal backwardation" by economist John Maynard Keynes. This is because he believed that a price movement like the one suggested by backwardation was not random but consistent with the prevailing market conditions.

Backwardation is the opposite of contango.

Learn how to us this market condition to your advantage; check out What's the best way to play backwardation in the futures market?

RELATED TERMS
  1. Roll Yield

    The amount of return generated in a backwardated futures market ...
  2. Backward Induction

    The process of deducing backwards from the end of a problem or ...
  3. Backward Integration

    A form of vertical integration that involves the purchase of ...
  4. Convergence

    The movement of the price of a futures contract towards the spot ...
  5. Contract Month

    The month in which a futures contract expires. The contract can ...
  6. Roll Forward

    To extend the expiration or maturity of an option or futures ...
Related Articles
  1. Investing

    What is the Theory of Backwardation?

    Backwardation occurs when the futures price of a commodity is lower than its market price today.
  2. Markets

    Contango Versus Normal Backwardation

    It’s important for both hedgers and speculators to know whether the commodity futures markets are in contango or normal backwardation.
  3. ETFs & Mutual Funds

    USO Vs. DBO: Comparing Oil ETFs

    Discover two major oil ETFs, The United States Oil Fund and The PowerShares DB Oil Fund, and the major differences between the two funds.
  4. Investing

    Options on Futures

    Options on futures contracts offer another way for day traders to use options. These are traded on the same exchange as the underlying futures contract. Traders should take care to understand ...
  5. Markets

    Crude Oil Prices: Comparing Future Price Vs. Current Market Price

    Discover the differences between oil futures market prices and oil spot market prices and what leads to the differences between the two.
  6. ETFs & Mutual Funds

    UNG Vs. UGA: Comparing Gas ETFs

    Discover the main similarities and differences between two major energy sector ETFs: The United States Natural Gas Fund and The United States Gasoline Fund.
  7. Investing

    What is Backward Integration?

    What is backward integration, and how can it affect industries?
  8. Trading

    The Difference Between Forwards and Futures

    Both forward and futures contracts allow investors to buy or sell an asset at a specific time and price.
  9. ETFs & Mutual Funds

    UNG: US Natural Gas ETF Performance Case Study

    Explore the performance of the United States Natural Gas Fund since 2012, including the influence of contango and backwardation on the fund's returns.
  10. Investing

    The Top 4 Equity Proxies For the Futures Markets (SPY, IWM)

    Futures markets have highly liquid equity proxies for nearly all major contracts, offering greater choices for traders and investors.
RELATED FAQS
  1. What's the best way to play backwardation in the futures market?

    Backwardation is a market condition in which a futures contract far from its delivery date is trading at a lower price than ... Read Answer >>
  2. Is backward integration the same thing as vertical integration?

    Learn if there are any differences between backward integration and vertical integration. Learn where on the production line ... Read Answer >>
  3. What is the best reason to pursue a backward integration?

    Learn if backward integration is a good or bad move for a business. Learn what backward integration does for a business's ... Read Answer >>
  4. What is backward integration and how does it relate to economies of scale?

    See how a firm can realize greater economies of scale by engaging in backward integration mergers with one or more of its ... Read Answer >>
  5. What does it mean when futures prices are in contango?

    a. The basis is positive.b. Future prices are higher than cash prices.c. The market is in backwardation.d. Supply disruptions ... Read Answer >>
  6. What are the disadvantages of backward integration for a mid-sized business seeking ...

    Learn more about backward vertical integration and the disadvantages of this business strategy for some small and midsized ... Read Answer >>
Hot Definitions
  1. Diversification

    A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique ...
  2. European Union - EU

    A group of European countries that participates in the world economy as one economic unit and operates under one official ...
  3. Sell-Off

    The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
  4. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
  5. Brexit

    The Brexit, an abbreviation of "British exit" that mirrors the term Grexit, refers to the possibility of Britain's withdrawal ...
  6. Underweight

    1. A situation where a portfolio does not hold a sufficient amount of a particular security when compared to the security's ...
Trading Center