Alert

10 Trades We Are Thankful For
tastytrade logo
Closing the Gap - Futures EditionContango and Backwardation | Jul 31, 2015
Up Next
    Closing the Gap - Futures EditionContango and BackwardationJul 31, 2015

    This segment explains two important related concepts of the futures markets, backwardation and contango, and explains their impact on ETFs (and thus ETF options). An understanding of this should help your trading.

    Contango and backwardation are terms frequently used when speaking about future prices. This segment explains what they mean and how they affect the products we trade. Also explained is the role of storage cost/carrying cost, the impact of supply and demand, what markets are usually in backwardation or contango and how ETFs that we might trade are affected.

    When the front month contracts are more expensive than back month contracts we are in backwardation. This is frequently the case when demand is outstripping supply. When the back month contracts are more expensive than front month contracts the markets are in contango. This is frequently seen when supply exceeds demand. Market sentiment and fear can also help determine if a market is in backwardation or contango.

    A graph was displayed of Crude Oil Futures from January 2014 to present. The graph displayed the different times when backwardation and contango occurred. A second graph showed how Crude Oil was in backwardation last year because of supply concerns which made the front months in Crude Oil more expensive than the back months as well as when contango occurs and the front moths are cheaper than the back months.

    The futures markets are in contango the majority of the time because of the cost of carry. This is important when trading ETFs based upon futures because of contango’s impact and the subsequent drag. The ETF USO uses futures to replicate spot crude. There is a loss each month in the “roll” (i.e. each month, the fund administrators sell the front-month and buy the back month) when the market is in contango (like now). This creates a drag that willl impact USO.

    In VIX futures, the curve is almost always in contango (over 80% of the time), as this creates a negative carrying cost for long VIX traders. This makes sense because long VIX positions act as insurance against market drawdowns. A graph was displayed of the VIX futures curve from August expiration to December 2015 expiration.

    VIX futures tend to go into backwardation when market crises occur and IV explodes. This is because the market prices in the mean-reverting tendency of IV and extremely high IV is unsustainable. A backwardated curve results in a positive carry for long VIX traders. Another graph displayed the VIX futures curve from January 2009 expiration to May 2009 expiration. In this rare case the VIX Futures went into backwardation as the graph shows.

    Watch this episode of “Closing The Gap Futures Edition” with Tom Sosnoff and Tony Battista to learn all about Contango and Backwardation in the futures markets and how it affects the ETFs and ETF options we like to trade.

    More like this

    tastytrade content is provided solely by tastytrade, Inc. (“tastytrade”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, transaction or investment strategy is suitable for any person. Trading securities can involve high risk and the loss of any funds invested. tastytrade, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors, and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastytrade is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. Supporting documentation for any claims (including claims made on behalf of options programs), comparison, statistics, or other technical data, if applicable, will be supplied upon request. tastytrade is not a licensed financial advisor, registered investment advisor, or a registered broker-dealer. Options, futures and futures options are not suitable for all investors. Prior to trading securities products, please read the Characteristics and Risks of Standardized Options and the Risk Disclosure for Futures and Options found on tastyworks.com. 

    tastytrade is a trademark/servicemark owned by tastytrade.

    tastyworks, Inc. ("tastyworks") is a registered broker-dealer and member of FINRA, NFA and SIPC. tastyworks offers self-directed brokerage accounts to its customers. tastyworks does not give financial or trading advice nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastyworks’ systems, services or products. tastyworks is a wholly owned subsidiary of tastytrade, Inc (“tastytrade”).

    tastyworks, Inc. (“tastyworks”) has entered into a Marketing Agreement with tastytrade (“Marketing Agent”) whereby tastyworks pays compensation to Marketing Agent to recommend tastyworks’ brokerage services. The existence of this Marketing Agreement should not be deemed as an endorsement or recommendation of Marketing Agent by tastyworks. tastytrade is the parent company of tastyworks. tastyworks and Marketing Agent are separate entities with their own products and services. tastytrade has different privacy policies than tastyworks.

    Quiet Foundation, Inc. (“Quiet Foundation”) is a wholly-owned subsidiary of tastytrade The information on quietfoundation.com is intended for U.S. residents only. All investing involves the risk of loss. Past performance is not a guarantee of future results. Quiet Foundation does not make suitability determinations, nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of Quiet Foundation’s systems, services or products.

    © copyright 2013 – 2022 tastytrade. All Rights Reserved. Applicable portions of the Terms of use on tastytrade.com apply. Reproduction, adaptation, distribution, public display, exhibition for profit, or storage in any electronic storage media in whole or in part is prohibited under penalty of law, provided that you may download tastytrade’s podcasts as necessary to view for personal use.