The Dance of Prices in the Futures Market: Understanding Convergence, Contango, and Backwardation
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Introduction: The Hidden Choreography of Market Moves
Imagine a stage where the performers aren't ballerinas, but prices. Futures and spot dance around each other like two magnets - sometimes drawing close in an elegant bow (convergence), sometimes the future seems too expensive (contango), and other times the present proves to be king (backwardation). But this dance doesn't happen in silence - it's a pulsating rhythm, dynamic changes, and constantly shifting choreography.
This dance isn't a random arrangement of movements. It's the result of precisely functioning market mechanisms that are worth understanding, at least at a basic level. There are many market participants for whom these phenomena are the foundation that allows them not just to survive, but to succeed. Understanding how they work gives you an edge, and as we know - in the world of investing, every edge matters.
So let's dive into this fascinating game of forces.
Today’s Price vs. Tomorrow’s Price - Two Prices, Two Worlds
Before we dive deeper into the world of futures, it's worth explaining two key concepts: spot price and futures price.
Spot price is simply the current value of a given commodity or instrument - how much you need to pay to have it "here and now." Futures price, on the other hand, is the price established today for buying (or selling) the same asset at a specific moment in the future. The difference? The futures price takes into account not only the current value, but also market expectations, storage costs, financing, and a whole mass of emotions related to what might happen in a week, month, or six months.
This difference is the fuel for the entire rest of the story about the futures market.
Convergence: The Force That Always Leads to the Finale
Convergence is like the inevitable ending of a movie. Regardless of how much the futures contract deviates from the spot price at the beginning, they must eventually meet. Why? Because a persistent price difference simply has no right to persist in a healthy market. Let me explain: imagine oil costs $70 on the market, and a futures contract for delivery tomorrow can be bought for $75. What will arbitrageurs do in this situation? They immediately buy the cheaper oil and sell the more expensive contract. They short the higher price while simultaneously opening longs on the lower one. The undervalued price starts to rise, and the overvalued one falls. It's precisely their quick actions that prevent prices from diverging for long and cause them to align. Convergence is the natural finale.
It's like gravitational attraction. The closer to the delivery date, the stronger the force of convergence. On the contract expiration day, futures and spot prices must be nearly identical. Otherwise, investors will immediately appear who will take advantage of the risk-free profit opportunity - and this never lasts long on modern markets.
It's worth remembering that this convergence mechanism applies not only to commodities. It works equally well in the stock index market, currencies, bonds, or even contracts on energy, inflation, or weather. Convergence is a universal phenomenon, and ignoring it is like entering the trading floor blindfolded.
Contango: When the Future Costs More
When the futures price is higher than spot, we call it contango. It's like the situation where you buy seasonal fruit in winter - apples are more expensive because someone had to harvest them earlier, store them in cold storage, secure them, and transport them. The storage cost and associated risk are factored into the price. Similarly in contango - the contract price includes not only the value of the commodity itself, but also all the costs of its "storage in time."
Let's apply this to the market: suppose you're storing barrels of oil. You have to pay for proper storage, security, purchase financing. These costs raise the price of the future contract. Additionally, if investors predict price increases - for example, due to geopolitical tensions or seasonal demand patterns - they're willing to pay even more for a contract with a longer maturity.
Contango is often the natural state for markets with high storage costs and easy access to the commodity. Precious metals, crude oil, agricultural products - all can remain in contango structure for long periods. But beware: for investors "rolling" positions, contango means regular costs.
Contango - The Real Story: The Case of Crude Oil
In 2020, the world saw how dramatic contango can be. The COVID-19 pandemic caused a decline in oil demand, and storage facilities quickly filled up. The result? The difference between spot and futures prices was record-breaking - one could speak of "super-contango." The May WTI Oil contract even reached deeply negative prices, while contracts with longer terms were significantly more expensive.
Some professional traders applied the cash-and-carry strategy here: they bought oil cheaply on the spot market, stored it, and simultaneously sold more expensive futures contracts.
Precious Metals - The Kingdom of Contango
Gold and silver are almost always in contango. Why? Because they have low storage costs, don't spoil, don't require special conditions, and their value relative to volume is enormous. Additionally, gold provides no income during storage, so the owner bears only costs. This makes futures prices almost always exceed spot prices.
Backwardation: When the Here and Now Matters Most
When the future market is valued lower than the present - we're dealing with backwardation (the opposite of contango). Imagine suddenly having enormous demand for corn due to drought. The spot price shoots up, but everyone knows that in 3 months the harvest will return to normal. The futures contract then costs less because the market expects the situation to normalize over time.
Backwardation often results from shortage here and now. Someone needs the commodity today and is willing to pay a premium for immediate availability. This could be a factory that will be forced to stop production without gas, a bakery without wheat flour, or a refinery without oil. Such situations drive up spot prices but don't necessarily affect contracts with longer terms.
This phenomenon is often read as a signal of demand strength - "we need this commodity here and now more than in the future." But beware - this can also mean the risk of dynamic, short-term price changes and requires deeper analysis.
Backwardation in Practice
- The energy sector (oil, gas) often experiences backwardation because shortages have immediate economic consequences.
- In the livestock market (e.g. cattle), backwardation appears when supply is limited—you can’t just “store animals for later” like you can with metals.
- Natural gas in winter: demand for heating often pushes spot prices above contracts for spring delivery.
Roll Yield: Quiet Tailwind, or a Headwind - When You Roll
Roll yield is a side effect of rolling contracts. When you have a contract that's about to expire, you must close it and buy the next one (i.e., roll it). And then comes the surprise:
- In contango: you sell lower and buy higher. In nominal terms, you lose on each roll.
- In backwardation: you sell higher and buy lower. So you nominally gain from rolling.
This seemingly small detail can, over the long term, eat up a significant portion of profits or, with the right setup, become a reliable source of advantage.
Example? Funds based on the VIX volatility index almost always suffer from negative roll yield. On the other hand, agricultural commodity markets, which regularly went through backwardation for decades, often offer positive rolling effects.
Roll yield is like a river current - you can flow with it or struggle against it. The key is knowing which direction it flows before you even jump into the water.
Roll Yield: Practical Implications
For long-term investors, roll yield can be crucial. For example, in the VIX market, chronic contango systematically eats away profits from long positions. On the other hand, in the agricultural market, where backwardation is frequent, roll yield is often positive and can generate profits even with stable spot prices.
What is the Futures Curve in practise?
Imagine that you arrange the prices of futures contracts on the same commodity, but with different expiration dates, on a single time axis. A characteristic curve emerges - it's precisely this that reveals how the market "sees" the future. If successive contracts are increasingly expensive, we're dealing with an upward curve, i.e., contango. When prices of distant contracts are lower than the nearest ones - that's backwardation.
The shape of this curve isn't just a chart for analysts - it's expectations, emotions, and market realities encoded in prices: storage costs, seasonality, fear of shortage or oversupply. All the concepts we're talking about today: convergence, contango, backwardation - are precisely different "dance arrangements" of this curve, which determine how the futures world really works - the world of future prices of a given commodity or asset.
The curve we’re talking about is the term structure, also called the futures curve or forward curve.
What drives the Futures Curve?
Think of the curve’s shape as a simple balance: the cost of carrying inventory over time versus the benefit of having the commodity on hand. When storage and financing are expensive, the curve tends to slope upward (contango) because futures prices “bake in” storage and capital costs.
When immediacy is valuable - low inventories, demand spikes, supply‑chain risks - the convenience yield rises and the curve can slope downward (backwardation).
Because of this simple balance, you’ll often see two companion concepts in futures markets:
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Convenience yield – the practical “bonus of having it” physically (assured supply, flexibility, fewer shutdown risks); the higher it is, the closer you are to backwardation.
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Cost of carry – the sum of financing, storage, and insurance; the higher it is (with a low convenience yield), the more the market leans toward contango.
What else drives the dance of the futures curve?
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Interest rates – higher rates tend to support contango; lower rates can tilt the curve toward backwardation.
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Inventory levels – low inventories often mean backwardation; ample stocks often mean contango.
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Seasonality – for instance, natural gas often flips into backwardation in winter and into contango in summer.
- Market expectations – the supply/demand outlook can keep a market in contango even amid oversupply.
Strategies: How to Use the Futures Curve
Understanding the structure of the futures curve gave birth to a completely new way of thinking about trading and investing. Players emerged who not only look at where the market is heading, but also how it gets to that goal. It's precisely these investors and traders analyzing term curves who created an entire arsenal of strategies based not on predicting the future, but on reading its shape. They have their schemes, their tools, and their way of looking at the market - often different from what's known from classical trend analysis or technical indicators.
Calendar Spreads - You buy a contract with a nearer term, sell one with a longer term. You count on the difference between them decreasing and you earn from this move. Perfect when you have good market knowledge and information about sentiment and market trends.
Storage Trade - This is already a classic in the oil market used in 2020. You buy physical commodity, store it, and simultaneously sell a futures contract at a higher price. Profit appears if it covers storage costs, so relatively little is needed.
Arbitrage - You look for situations where differences between spot and futures prices are so large that you can profit, considering even all costs. Usually, professionals with access to cheap financing and fast algorithms scanning the entire market in an instant have the biggest field for action - an opportunity for almost risk-free profit appears for them.
Who's Playing This Game?
Producers: They sell contracts to secure future revenues (hedging). For them, contango is often very beneficial because it allows them to "lock in" a higher selling price for the future.
Traders: They use the structure of the futures curve to look for opportunities arising from its shape and changes over time. When they expect the market to move from backwardation to contango (or vice versa), they take appropriate positions to profit from price movements between contracts with different terms. They also use strategies based on roll yield - e.g., they buy contracts in backwardation to benefit from the positive rolling effect or avoid exposure to markets with chronic contango, where systematic rolling brings losses. Their advantage lies not only in predicting market direction, but also in understanding how the "future" recorded in futures prices "looks."
Funds and ETFs: For them, the curve structure is often a silent long-term enemy. A fund investing passively, through futures contracts, in the commodity market in contango (e.g., the oil market - where usually each successive contract is more expensive) can systematically lose just through position rolling.
But what if you don't trade futures directly, but use CFDs? Does all this knowledge about rolling, contango, and backwardation have any significance for you at all?
What Does This All Mean for CFD Investors?
At this stage, it's worth pausing and asking: how does this entire dance of futures, contango, backwardation, and rolling translate to the world of CFD investors? Although at first glance CFDs seem to be a completely different instrument, their foundations are deeply rooted precisely in futures market mechanisms. It's no coincidence that CFD contracts are said to be instruments derived from futures contracts.
Rolling - The Invisible Mechanism in the Background
For a CFD investor, the entire process of rolling futures contracts is almost invisible - the broker takes care of ensuring that the client's position reflects the current situation in the underlying market. When a series of futures contracts expires, the broker automatically "transfers" the client's exposure to a new series, and the price difference between the old and new contract (i.e., the effect of contango or backwardation) is settled on the investor's account in the form of a financial adjustment. This is precisely why, even if you hold a CFD position for many months, theoretically you don't have to worry about the underlying contract expiring - the broker does all the work behind the scenes. Unfortunately, there's also a dangerous catch.
Remember that although the broker will take care of rolling your position itself, it won't do this with defensive orders. Stop Loss or Take Profit won't "jump" automatically to new levels after changing the contract series. In practice, this means that on the rolling day, unexpected activation of SL or TP often occurs - sometimes completely not where we planned - which, unfortunately, creates unforeseen losses. Does this mean we shouldn't use SL and TP? Quite the opposite, but it should be done consciously and with full knowledge of determining activity levels of "big players" causing the biggest movements on the chart (whose movements can be learned to track), keeping in mind also contract expiration dates (and strategies for playing individual series).
When investing in CFDs, you should always keep an eye on your broker's rolling calendar and not leave such things to chance. (I described the topic of rolling in detail and how to practically protect yourself from unforeseen, costly consequences - in an article available as part of mentoring for my course participants.)
And if we're talking about costs: remember that swap fees in CFDs can be as surprising as market volatility on the day of macro data publication - unlike futures contracts. But that's a topic for a separate story.
One Last Thing - Learn to Dance
Futures markets are like dancers at a ball. Every price move is shaped by many forces — production, decisions by the largest market participants, weather, politics, investor emotions, and crowd sentiment. If the goal is to move confidently on this floor, it helps to recognize when contango starts playing and when backwardation takes the stage.
Let this dance also become your advantage. Learn the rhythm, read the tempo, and move with confident steps. On this floor, it isn’t the person who knows the most definitions who wins, but the one who can feel the market’s music and adapt to it.
Q&A, key concepts, and a practical wrap‑up on Convergence, Contango, and Backwardation
Available exclusively to students of Jacek Pobłocki’s Academy of ANALYSIS.
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Jacek Pobłocki
Financial Analyst of Markets and Securities
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