Backwardation

AAA

DEFINITION of 'Backwardation'

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.

INVESTOPEDIA EXPLAINS '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. Keynesian Economics

    An economic theory of total spending in the economy and its effects ...
  2. Forwardation

    A term used in pricing futures contracts. Forwardation is a ...
  3. Cash Market

    The marketplace for immediate settlement of transactions involving ...
  4. Commodity

    1. A basic good used in commerce that is interchangeable with ...
  5. Futures Strip

    The sale or purchase of futures in sequential delivery months ...
  6. Roll Yield

    The amount of return generated in a backwardated futures market ...
RELATED FAQS
  1. How are commodity spot prices different than futures prices?

    Commodity spot prices and futures prices are different quotes for different types of contracts. The spot price is the current ... Read Full Answer >>
  2. How do commodity spot prices indicate future price movements?

    Commodity spot prices indicate future price movements because commodity futures prices are calculated using spot prices. ... Read Full Answer >>
  3. Where did market to market (MTM) accounting come from?

    Mark to market accounting has been around in concept since the stock market began; however, it was not officially part of ... Read Full Answer >>
  4. Why is market to market (MTM) accounting considered controversial?

    Mark to market accounting has been an integral component of generally accepted accounting principles (GAAP) in the United ... Read Full Answer >>
  5. What is the difference between economic value and market value?

    The difference between market value and economic value is that the former represents the minimum amount the customer is willing ... Read Full Answer >>
  6. How do I set a strike price for a future?

    Strike prices can be set for put and call options, but investors engaged in futures contracts are obligated to trade the ... Read Full Answer >>
Related Articles
  1. Options & Futures

    Contango Vs. Normal Backwardation

    Learn about the futures curve and what its shape means for hedgers and speculators.
  2. Forex Education

    Forex: Wading Into The Currency Market

    We go over the ground rules and available resources needed for this undertaking.
  3. Active Trading

    Commodities: The Portfolio Hedge

    These diverse asset classes can provide downside protection and upside potential. Find out how to use them.
  4. Insurance

    Futures Fundamentals

    For those who are new to futures but want a solid understanding of them, this tutorial explains what futures contracts are, how they work and why investors use them.
  5. Options & Futures

    Interpreting Overnight Action In The Index Futures

    Overnight action in index futures sets the tone for the U.S. market day. Traders can use 24-hour index futures charts to predict action in the coming day.
  6. Investing Basics

    What Does Spot Price Mean?

    Spot price is the current price at which a security may be bought or sold.
  7. Investing Basics

    What Does a Clearing House Do?

    A clearing house is a third-party agency or separate entity that acts as a go-between for buyers and sellers in financial markets.
  8. Investing Basics

    What is Meant by Implied Volatility?

    The estimated volatility of a security's price.
  9. Economics

    How Gloomy Headlines Support Eurozone Stocks

    It's hard to miss the many headlines on Europe lately with news ranging from Greece’s debt saga to the details of ongoing European Central Bank stimulus.
  10. Investing Basics

    Explaining Credit Spread

    A credit spread has two different meanings, one referring to bonds, the other to options.

You May Also Like

Hot Definitions
  1. Radner Equilibrium

    A theory suggesting that if economic decision makers have unlimited computational capacity for choice among strategies, then ...
  2. Inbound Cash Flow

    Any currency that a company or individual receives through conducting a transaction with another party. Inbound cash flow ...
  3. Social Security

    A United States federal program of social insurance and benefits developed in 1935. The Social Security program's benefits ...
  4. American Dream

    The belief that anyone, regardless of where they were born or what class they were born into, can attain their own version ...
  5. Multicurrency Note Facility

    A credit facility that finances short- to medium-term Euro notes. Multicurrency note facilities are denominated in many currencies. ...
  6. National Currency

    The currency or legal tender issued by a nation's central bank or monetary authority. The national currency of a nation is ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!