Contango & Backwardation are linked with Futures market.
As we know Spot Price is the Current Market price of any asset and Futures price is the price predicted for future.
Lets take an example of Crude Oil:
When purchasing crude oil, if we take the delivery now, the space, insurance and other cost involved in storing the crude oil reduces to the supplier and hence the price is low for crude oil compared to future delivery.
The price for storage and other expenses increases for future delivery and henceforth the cost is higher. This is called Contango
Lets consider the demand is very high and the company cannot supply the crude oil to all its customers, in that case the futures price will be reduced and current spot price will be high.
similarly, when there is an operational concern like pipeline maintenance work or damage, the company cannot supply the crude oil immediately. In this scenario of Futures price is low pushing customers to get delivery in future period and spot price high. This is called Backwardation
Futures Price = Spot Price + Cost to Carry
In Contango, the cost to carry will be positive and in Backwardation, the cost to carry will be negative
As we know Spot Price is the Current Market price of any asset and Futures price is the price predicted for future.
Lets take an example of Crude Oil:
When purchasing crude oil, if we take the delivery now, the space, insurance and other cost involved in storing the crude oil reduces to the supplier and hence the price is low for crude oil compared to future delivery.
The price for storage and other expenses increases for future delivery and henceforth the cost is higher. This is called Contango
Lets consider the demand is very high and the company cannot supply the crude oil to all its customers, in that case the futures price will be reduced and current spot price will be high.
similarly, when there is an operational concern like pipeline maintenance work or damage, the company cannot supply the crude oil immediately. In this scenario of Futures price is low pushing customers to get delivery in future period and spot price high. This is called Backwardation
Futures Price = Spot Price + Cost to Carry
In Contango, the cost to carry will be positive and in Backwardation, the cost to carry will be negative
Lets consider the same scenario in indices /stocks, currently Nifty spot price is 100 points higher than Nifty Futures, this indicates
1. The demand is very high for Nifty Buy
2. Short covering is probably happening due to sellers by start of May 2020, tend to buy back now
Best Regards,
B G Nareshkumar.
No comments:
Post a Comment