when prices are in contango investors are willing to pay more for a commodity that will be delivered in the future the difference between the spot and future prices is referred to as a premium 
the premium usually includes the cost of carry which is a term that refers to the costs of holding an asset for a certain period the cost of carry for commodities generally includes storage insurance or depreciation due to spoiling or rotting if the commodity is an agricultural or meat product in all futures market scenarios the futures prices will usually converge toward the spot prices as the contracts approach expiration expiry that happens because the expiry date is drawing closer and is more reflective of the actual value of the commodity contract traders are going to pay closer and closer to the spot market values additionally because there is a large number of buyers and sellers the market becomes more efficient and eliminates large arbitrage opportunities that said a market in contango will see gradual decreases in the price to meet the spot price at expiration another important factor is that most futures traders and investors won t want to take possession of the underlying commodities they will close their positions long before expiry to reduce the risk of needing to store say 1 000 barrels of crude oil overall futures markets involve a substantial amount of speculation when contracts are further away from expiration they are more speculative but there are several reasons a trader would want to lock in a higher futures price as mentioned the cost of carry is one common reason for buying commodities futures producers have other reasons to pay more for futures than the spot price producers make commodity purchases as needed based on their inventory how they manage their inventory may be influenced by the spot price vs the futures price however they will generally follow the spot and futures prices while seeking to achieve the best cost efficiency some producers may believe that the spot price will rise rather than fall over time therefore they hedge by offering slightly higher prices for future contracts to try and influence contango causes of contangodifferent markets are affected by various factors for instance crops can be affected by weather and oil can be affected by geopolitical instabilities these instabilities or uncertainties can cause investors and traders to anticipate price drops or increases and to respond accordingly for the most part contango is caused by example of contangoone of the most common markets that see contango is the crude oil futures market it experienced contango in 2020 the organization of the petroleum exporting countries opec called it super contango meaning that the difference between futures and spot prices was very pronounced 2on feb 2023 brent crude front month contracts spot price settled at 83 16 front month april while future months settled at 3this is not an example of contango but if the prices had been reversed to this the market would have been in contango overtime arbitrage buying and selling an asset simultaneously in different markets to take advantage of price differences opportunities are reduced because futures prices and spot prices converge the effects of contango on investmentsgenerally contango causes investors to believe that prices are going to continue rising it indicates that demand is higher than supply in the short term causing futures prices to rise futures prices rise above spot prices because investors become comfortable paying more for the future assets however commodity and volatility funds are structured to buy short term futures as a result contango can eat away at these funds value because it can reduce the capital a fund holds for purchases for the next period contango vs backwardationcontango sometimes referred to as forwardation is the opposite of backwardation in the futures markets the forward curve can be in contango or backwardation a market is in backwardation when the futures price is below the spot price for a particular asset in general backwardation can be the result of current supply and demand factors it may be signaling that investors are expecting asset prices to fall over time because investors base their futures bids on how they foresee the market turning out sentiment plays a significant part in backwardation investors might anticipate a declining market and begin to sell short futures contracts with strike prices below the current spot price and buy the contracts for a profit a market in backwardation has a forward curve that is downward sloping as shown below advantages and disadvantages of contangoarbitrage opportunitiesinflation protectionshort selling opportunitiesfutures contracts can be rolled forwardhigh risk when attempting to profitone way to benefit from contango is through arbitrage strategies for example an arbitrageur might buy a commodity at the spot price and then immediately sell it at a higher futures price as futures contracts near expiration this type of arbitrage increases the spot and futures prices actually converge as expiration approaches due to arbitrage there is also another approach to profiting from contango futures prices above the spot price can signal higher prices in the future particularly when inflation is high speculators may buy more of the commodity experiencing contango in an attempt to profit from higher expected prices in the future they might be able to make even more money by buying futures contracts however that strategy only works if actual prices in the future exceed futures prices as mentioned previously traders can profit from short selling opportunities created by contango the most significant disadvantage of contango comes from automatically rolling forward contracts which is a common strategy for commodity etfs investors who buy commodity contracts when markets are in contango tend to lose some money when the futures contracts expire higher than the spot price fortunately the loss caused by contango is limited to commodity etfs that use futures contracts such as oil etfs gold etfs and other etfs that hold actual commodities for investors do not suffer from contango the risks of trading in a contango market are increased when you re seeking profits because trades are being made at a premium there is always the possibility that the market will fall to levels far below the price you ve agreed to pay causing losses 