Contango

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DEFINITION of 'Contango'

A situation where the futures price of a commodity is above the expected future spot price. Contango refers to a situation where the future spot price is below the current price, and people are willing to pay more for a commodity at some point in the future than the actual expected price of the commodity. This may be due to people's desire to pay a premium to have the commodity in the future rather than paying the costs of storage and carry costs of buying the commodity today.

BREAKING DOWN 'Contango'

When a market is "in contango" when the delivery price of a particular futures contract has to converge downward to meet the futures price. If prices did not converge, it would set up an opportunity for investors to profit from arbitrage. Contango situations can be costly to investors holding net long positions since futures prices are falling. For example, assume an investor goes long a futures contract today at $100. The contract is due in one year. If the expected future spot price is $70, the market is in contango, and the futures price will have to fall (unless the future spot price changes) to converge with the expected future spot price.

The opposite of contango is known as normal backwardation. A market is "in backwardation" when the futures price is below the expected future spot price for a particular commodity. This is favorable for investors who have long positions since they want the futures price to rise.

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