Legal Definitions - contango

Contango describes a specific condition in financial markets, particularly for futures contracts. It occurs when the price of a futures contract for a future delivery date is higher than the price for an earlier delivery date. In simpler terms, if you agree to buy a commodity or financial asset at a set price for delivery further in the future, you pay a premium compared to buying it for delivery sooner. This premium often reflects the costs associated with holding the underlying asset over time, such as storage, insurance, and financing.

• Example 1: Crude Oil Futures

  Imagine an airline company that wants to secure its fuel costs for the upcoming year. They look at futures contracts for crude oil. They find that a contract for crude oil to be delivered three months from now is priced at $80 per barrel, but a contract for delivery nine months from now is priced at $84 per barrel.

  This situation demonstrates contango because the longer-term contract (nine months out) is more expensive than the shorter-term contract (three months out). The $4 difference per barrel reflects the market's expectation of the costs involved in storing, insuring, and financing that crude oil for an additional six months until the later delivery date.

• Example 2: Agricultural Commodities (Wheat)

  A large bakery chain needs to ensure a consistent supply of wheat for its operations. When examining wheat futures, they notice that contracts for wheat delivery in six months are trading at a higher price than contracts for delivery in two months.

  This is an example of contango in the agricultural market. The premium for the six-month contract accounts for the costs of storing the harvested wheat, protecting it from pests, and the interest on the capital tied up in the commodity for the additional four months until the later delivery.

• Example 3: Precious Metals (Silver)

  An industrial manufacturer uses silver in its products and wants to lock in a price for a large quantity. They observe that futures contracts for silver to be delivered in one year are trading at a higher price than contracts for immediate delivery.

  This scenario illustrates contango for silver. The higher price for the one-year delivery contract incorporates the "cost of carry" – the expenses associated with holding the physical silver for an entire year, such as secure storage fees, insurance against theft or damage, and the opportunity cost of the capital invested in the silver.