Our last episode covered the basics of trading futures calendar spreads. In this episode, we build on that foundation.
Backwardation and contango are two important concepts to understand when learning how to trade futures calendar spreads.
Contango
Contango is when the front month contracts is priced lower than the deferred (back) months. For example, a corn contract in Sep 15’ costs 402’0 and a contract in Mar 16’ is 417’5.
Contango markets are referred to as ‘normal’ markets because this is the expected behavior. It’s expected because the deferred months should cost a little more than the front month due to expenses like the cost of carry (storage costs, insurance, and interest rate payments).
Backwardation
Backwardation is when the front month contracts is priced higher than the deferred months. For example, an oil contract in Sep 15’ costs 58’0 and a contract in Mar 16’ is 56’5.
Backwardated markets are typically called ‘inverted’ markets and typically occurs during bull markets.When there is a substantial supply issue or increase in demand, the front months will start to go up faster than the back months.
Inter-commodity futures spreads are spreads between different futures markets (i.e. a futures spread between corn vs. soybeans.
There are many types of inter-market spreads, such as:
To learn more about inter-commodity futures spread, check out this episode.
Strategies: Futures Calendar Spreads
Products Discussed In This Episode: N/A
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