Calculation and mechanics
What counts is the comparison of neighbouring contracts, often the first and second expiry month. If the second contract is above the first, the front part of the curve is in contango. If it is below, the curve is in backwardation.
A term structure does not have to run the same way across all maturities. In seasonal markets the front part can, for example, be in backwardation while later months show contango again.
For storable commodities, storage, financing and insurance costs can contribute to later contracts trading higher. Backwardation can arise when near-term availability is tight, for example due to higher demand or low inventories. Expectations, risk premiums and seasonal factors also shape the curve.
Contango is also the more common state of the VIX Futures Curve. Backwardation occurs there mainly in phases of clearly elevated short-term volatility.
Anyone holding a futures position across several expiry dates has to roll it into the next contract regularly. How the shape of the curve affects performance in the process is described by the Roll Yield.
Contango: price 2nd contract > price 1st contract. Backwardation: price 2nd contract < price 1st contract.
Distinction
The Futures Term Structure is the whole curve across all expiry dates. Contango and backwardation describe its slope.
The spot price of the underlying is not a futures contract and is therefore not directly part of the futures curve. It can, however, serve as an additional reference point.
The VIX/VIX3M ratio also describes the relative shape of different volatility horizons but is based on index values rather than futures prices. A value below 1 shows that the volatility priced in for 30 days is below that for three months. This corresponds to a contango-like shape.
Related terms
- Futures Term Structure (Futures curve, forward curve)
- Roll Yield (Roll return, roll effect)
- VIX Futures Curve (VIX term structure, VX contracts)
- Front Month and Month Codes (Front contract, F G H J K M N Q U V X Z)
All market and analytical information is provided for educational and analytical purposes only and does not constitute investment advice or a trading recommendation.