Contango vs Backwardation: What Futures Traders Must Understand
If you don’t understand contango vs backwardation, you don’t understand how futures prices are structured, and you definitely don’t understand what you’re paying or earning when you roll a contract.
What the Futures Curve Is
The futures curve is just a chart of prices for different contract months. Its shape tells you how the market expects the underlying to behave over time.
This directly affects roll cost, long-term profitability, and how a futures price diverges from the spot market.
Contango: When Future Prices Rise Over Time
Contango means distant futures contracts are more expensive than near-term contracts. This is normal in markets where storage, insurance, or financing costs exist—like crude oil or metals.
Contango characteristics
- Deferred contracts trade at higher prices.
- Rolling long positions usually costs money (negative roll yield).
- Markets with high storage costs naturally sit in contango.
Example: If the front-month crude oil contract is $75 and the next month is $76.20, the market is in contango.
Backwardation: When Future Prices Drop Over Time
Backwardation means far-dated contracts cost less than near-term ones. This happens when there’s immediate demand or tight supply.
Backwardation characteristics
- Deferred contracts trade below the front month.
- Rolling long positions can actually earn money (positive roll yield).
- Common in commodities facing short-term shortages.
Example: If front-month natural gas is $3.10 and next month is $2.75, that’s backwardation.
Contango vs Backwardation Side-by-Side
| Feature | Contango | Backwardation |
|---|---|---|
| Curve Shape | Upward sloping | Downward sloping |
| Deferred Prices | Higher | Lower |
| Impact on Long Rolls | Cost money | Earn money |
| Common In | Oil, metals, grains | Shortage-driven markets |
How This Impacts Your Roll
When you roll a futures contract, you’re closing the expiring month and opening the next one. The difference between the two prices is your roll yield—positive or negative.
Roll yield rules
- Contango → you pay to roll.
- Backwardation → you get paid to roll.
- Roll cost is real P&L, not theoretical.
Why This Matters Even for Short-Term Traders
Even if you don’t trade long-term, contango vs backwardation affects volatility, liquidity, and how far months track spot. It also affects prop firm rules, margin changes, and big event-driven moves.
The Bottom Line
Contango and backwardation shape the entire futures market. They impact roll cost, contract pricing, and even your expected profit curve. If you trade futures, you need to know which structure you’re trading into—because the curve can help you or bleed you, depending on what you ignore.