Confusion over the concepts of Contango and Normal Contango
These terms seem to be used interchangeably, however they signal opposite attributes (bullish/bearish).
1. Wall Street Oasis Definition: Contango is a trading term used to refer to a situation where the price of a future for a specific asset is higher than the expected spot price at the time of the expiration of the future. For example, if it is currently January 2012 and the price of a Sept12 gold future is $1800 but the expected price of gold in September 2012 is only $1700, there is contango. As a result of contango, the future price is expected to tend to the estimated price at the time of expiration as the expiration date approaches. To use the example above, as it gets closer to September 2012 the gold future price will tend to $1700. Source: https://www.wallstreetoasis.com/finance-dictionar…
2. Investopedia Definition: Contango is when the futures price is above the expected future spot price. Because the futures price must converge on the expected future spot price, contango implies futures prices are falling (bearish) over time as new information brings them into line with the expected future spot price. Source: https://www.investopedia.com/articles/07/contango…
3. For Dummies Definition: When the front month trades higher than the current month, this market condition is known as contango. The market is also in contango when the price of the front month is higher than the spot market, and also when late delivery months are higher than near delivery months. As the contract extends into the future, the price of the contract increases. Contango is thus a bullish indicator, showing that the market expects the price of the futures contract to increase steadily into the future. Source: https://www.dummies.com/personal-finance/investin…
From what I learned, the first 2 definitions are "Normal Contango" where future price is higher than the future expected spot price, signaling a decline (bearish signal) in the future price as it falls to the future expected spot price.
The the third definition is what I've learned to be simply "Contango", where the spot price or current future price, is lower than the front month future price (or any other layer expiry). This is a bullish indicator"
Can an experienced trader let me know what I'm missing about these concepts?
First, contango is not a bullish indicator in any way. The best way to understand this is using commodities. Let's use corn for example. If the stocks of corn are plentiful, the market offers a premium to those (farmers) who are willing to store and keep their corn supply off the market for a while. The contango/carry market is applicable here. That essentially means the first deferred contract (Mar19) is trading higher than the nearby contract (Dec18). The difference between the two contracts is the storage costs for the farmers. In order to store the corn, there are a lot of costs (storage fees, opportunity costs, drying costs, etc.)
That said, please do not make the mistake of thinking contango as a bullish indicator. Just because the E-Mini S&P is in contango, does not actually mean it is a clear sign to go long. Finally, there is no normal or abnormal contango. Cheers!
It’s basically just a costs or storage/financing.
But contracts do go in backward action too.
Usually it’s a sign that the market doesn’t have enough of a product in the short term. Best example is a hurricane knocking out some refineries. Anyone with gasoline will get a premium for having it available today versus later. But this can occur in more normal markets too.
Unless real financial distress exists stock future contract spreads are just differences between dividends and interest rates.
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