Traders with access to physical oil and storage can make substantial profits in a contango market. Other traders may seek to profit on a storage shortage by placing a spread trade betting on the contango structure of the market to increase.
Contango means that the spot price of oil is lower than future contracts for oil. A futures contract is a legal agreement to buy or sell a physical commodity at some point in the future. The spot market is the current cash trading price for that commodity. This represents a contango futures term structure. At some point, the futures price will converge to the spot price, whether the futures price is above or below the spot price.
In this situation, a trader who controls physical barrels of oil and has access to storage can easily lock in a profit. By locking in that profit at the higher price, and then sitting on the physical oil for a couple of months, a trader can realize substantial gains. One futures contract of oil represents 1, physical barrels.
There will be storage and other transactional costs for the trade. If traders are all jumping into storing oil as part of a contango trade, the price for storage will likely increase as it is in greater demand. Floating storage on oil tankers is in greater demand during contango periods. Physical commodity traders may seek to store millions of barrels on oil tankers. Futures contracts for oil are settled by physical delivery of the oil.
As a practical matter, most physically settled futures contracts are offset in the market before going to the delivery stage. Another way for traders to profit off a contango market is to place a spread trade. A trader would short the spot month contract and buy the further out month. This trade would profit if the market increases its contango structure. The trade would lose money if the market reverts to a normal backwardation structure.
In backwardation, the spot price is higher than the price for farther out contracts. This would be a market in backwardation. Oil in particular, as well as other energy commodities, are subject to a backwardation term structure because short-term supply fears have a tendency to drive up the spot month price. These factors could include weather issues or political instability in the Middle East.
Precious metals are less likely to suffer from backwardation, since supply is generally not subject to interruption as energy commodities are. Dictionary Term Of The Day. How much a fixed asset is worth at the end of its lease, or at the end of its useful Broker Reviews Find the best broker for your trading or investing needs See Reviews. Sophisticated content for financial advisors around investment strategies, industry trends, and advisor education. A celebration of the most influential advisors and their contributions to critical conversations on finance.
Become a day trader. How can traders use contango to take advantage of the storage shortage for crude oil? By Investopedia April 13, — 1: The basis is positive. Future prices are higher than cash prices. The market is in backwardation. Backwardation is a market condition in which a futures contract far from its delivery date is trading at a lower price than Learn the common factors influencing the spot rate for an asset including the bid-ask spread and the forward term structure Learn about the futures curve and what its shape means for hedgers and speculators.
The United States Oil Fund is better suited to short-term investors who actively manage their portfolios. Learn about the risks and rewards of trading oil futures contracts. Read about a few strategies to limit the risk in trading oil futures contracts. Hedge against rising energy prices and diversify your portfolio with these funds.
Explore the performance of the United States Natural Gas Fund since , including the influence of contango and backwardation on the fund's returns. Backwardation occurs when the futures price of a commodity is lower than its market price today. While some exposure to commodities can enhance a portfolio, it is key to understand the investment vehicle you've chosen, or you could be in for a rude awakening. How much a fixed asset is worth at the end of its lease, or at the end of its useful life.
If you lease a car for three years, A target hash is a number that a hashed block header must be less than or equal to in order for a new block to be awarded. Payout ratio is the proportion of earnings paid out as dividends to shareholders, typically expressed as a percentage.
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