Contango vs. Backwardation in Derivatives Markets
Understanding positive vs. negative roll yields, physical inventory scarcity, and commodity ETF structural drag.
1. The Geometry of Futures Pricing
The relationship between the immediate spot price and futures contracts expiring across future calendar months defines the term structure of commodity and financial futures:
Contango ($F > S$)
Futures price is higher than spot price. Reflects financing interest, warehousing, and insurance costs. Investors in rolling commodity funds suffer negative roll yield.
Backwardation ($F < S$)
Futures price is lower than spot price. Indicates acute immediate physical supply scarcity or strong commercial convenience yield, generating positive roll yield.
2. Roll Yield Mechanics for Commodity Investors
Passive commodity ETFs (such as USO for crude oil or UNG for natural gas) do not hold physical inventory. To maintain exposure, they must routinely sell expiring near-month contracts and buy more expensive next-month contracts during contango — resulting in continuous structural underperformance relative to spot commodity prices.