You need to be familiar with a couple technical terms related to movements in the commodity futures markets if you want to successfully trade futures contracts. (Even by Wall Street standards, these terms are kind of out there.)
Contango in commodity futures
Futures markets, by definition, are predicated on the future price of a commodity. Analyzing where the future price of a commodity is heading is what futures trading is all about. Because futures contracts are available for different months throughout the year, the price of the contracts changes from month to month.
When the front month trades higher than the current month, this market condition is known as contango. The market is also in contango when the price of the front month is higher than the spot market, and also when late delivery months are higher than near delivery months.
| Month | Settlement Price |
|---|---|
| December 2010 | $82.68 |
| January 2011 | $83.40 |
| February 2011 | $83.98 |
| March 2011 | $84.45 |
| April 2011 | $84.94 |
| May 2011 | $85.00 |
As the contract extends into the future, the price of the contract increases. Contango is thus a bullish indicator, showing that the market expects the price of the futures contract to increase steadily into the future.
Backwardation in commodity futures
Backwardation is the opposite of contango. When a market is experiencing backwardation, the contracts for future months are decreasing in value relative to the current and most recent months. The spot price is thus greater than the front month, which is greater than future delivery months.
| Month | Settlement Price |
|---|---|
| July 2006 | $3.08 |
| August 2006 | $3.07 |
| September 2006 | $3.04 |
A market in backwardation is a bearish sign because traders expect prices over the long term to decrease.
