Contango

1. Definition

Contango is a situation in the futures market where the futures price of a commodity is higher than the spot price, or where longer-dated futures contracts are priced higher than shorter-dated contracts. This market condition is often referred to as a Normal Market.

2. Causes

Contango typically occurs because futures prices include the Cost of Carry associated with holding the asset until maturity.

$$ \text{Futures Price} = \text{Spot Price} + \text{Cost of Carry} $$

• Storage Costs: Expenses related to warehousing and insuring physical commodities like crude oil, gold, or grains.
• Interest Costs: The opportunity cost (interest) of the capital tied up in purchasing the physical asset.

3. Investment Impact

Investors holding long positions in a contango market face Negative Roll Yield when rolling over contracts. * The process involves selling the expiring, cheaper contract and buying the more expensive next-month contract. * Consequently, even if the spot price of the underlying asset remains flat, the value of futures-based ETFs or ETNs can erode over time due to these recurring costs.