@sammyjny Yes, I agree ... I am planning (when I get time) to apply some of the normal backwardation/contango theory to actual commodity curves, when I get time, thanks!
@watcher222: great point, we don't observe the EFSP. The "theory" is that, if the underlying has any systemic risk, the F < EFSP by risk premium. Think about the long forward position: why would he commit to zero future profit it he assumes risk? He wouldn't, he expects a difference like he expects compensation for risk beared (i.e., theory of normal backwardation)
Yes, by giving the (observed) contango, it implies the other factors (lease rate) are incorporated such that the forward curve = Spot*exp(4%*T), for example if assume continuous
Great question. I posted it to our forum (daily FRM Fun) where me and 2 others gave our detailed answer. My short version is that under a theory of normal, the S(t) is uncertain (volatile) such that F(0) must be < E[S(t)] due to risk aversion
one question about oil: the graph shows backwardation so the future price is lower than the actual spot price (or at least, the near term future contract price is higher than longer term future). If I should interpret that, I'd say that operators find urgent a short term buy for oil rather than buy it in the future.But, according to convenience yield/storage costs, I thought that a oil buyer would prefer pay a higher price for the convenience of NOT paying for storage. So, they would pay a "premium" for keeping the oil in the hands of seller until the future day deliver. In that case....shouldn't be in contango???
Thanks for the lesson. I do have one question. With backwardation, as the case with crude oil recently, this would suggest that one should either hold short positions or simply dump the stock, right? However I keep hearing that this is not the case with Gold and Silvers recent backwardation. Many reports on backwardation in regards to PM's is suggesting something else (currency crisis). Why and why does it not indicate a future dump of COMEX contracts?
thanks very much for this insightful video. I was wondering if u could if you could share ur views on this scenario. I am working on an assignment involving contangos. What does it mean if we say: the current gold spot price is $300/oz and the current forward contango is 4% nominal per annum. Does it imply an increase in 4% of the current spot price to give us our forward prices? Will expect ur reply soon
not necessarily a deficit. If you look at the tremendous amount of speculative buyers of commodity futures, the signal could be wholly driven by some sort of non-agricultural market factors. From simple things like "my hedge fund bought 10 billion dollars worth of gas futures and now the price is tanking, forcing me to liquidate these positions, driving them further down' to 'Russia closed its grain exports 6 months ago but the threat to their grain was a chimera and now the market is flooded.."
So when silver had a price spike to $50 an ounce, and people would only buy at $35 an ounce, would that be considered contango leading to forward backwardation?
So when a market is in backwardation for, say, an agri commodity, is the market giving a signal to producers to sell now rather than later? Probably because there will be a deficit in the future? Just trying to see how this would apply in real life. Cheers.
Thank you for your insightful video?just one question, does future/forward prices changes continuously and price quoted by business network like bloomberg or on wall street journal are future price or spot price?
Hello Mr Harper, Could you help me to understand why in the crude oil future markets, lots of traders often trade Jun/Dec & Dec red Dec future calendar spread, are there any fundamental reasons behind this?
The expected futures spot price includes a risk premium in its required rate of return due to the risk-averse nature of investors. Whereas the futures price only has the risk-free rate as its required rate of return (no risk premium) due to the risk-neutral nature of pricing derivatives. This idea of risk-neutrality in derivative pricing is key. If we've already arrived at a risk-averse price for the underlying, and you're buying something that derives its value off the underlying, you should be risk-neutral at that point because the underlying is already priced out for risk-aversion.
@britoca how about "ass-backwardation" lol THINK about volatility Futures !!! we have a flash crash and the back months get backwards i.e. like options in futures trading at discount IF that makes sense -G
the point? learning. In some subjects, people like to learn stuff, to, you know improve themselves. For example, you can even learn how to type these days :)
Seems like a nice guy but he immediately turned me off. A futures term structure curve is not "in" backwardation or contango. The curves are either inverted or not. If they are inverted they "anticipate" backwardation" and anticipate contango if the curve is rising between two dates. In that sense, contango and backwardation are kind of verbs and not nouns, per se.
@britoca totally agree. We should just use "inverted" for backwardation (with less chance to be confused with "normal backwardation")
@sammyjny Yes, I agree ... I am planning (when I get time) to apply some of the normal backwardation/contango theory to actual commodity curves, when I get time, thanks!
@watcher222: great point, we don't observe the EFSP. The "theory" is that, if the underlying has any systemic risk, the F < EFSP by risk premium. Think about the long forward position: why would he commit to zero future profit it he assumes risk? He wouldn't, he expects a difference like he expects compensation for risk beared (i.e., theory of normal backwardation)
This is crystal clear explanation... I finally got it! Thanks a million!
You're welcome! Thank you for watching!
sure thing, if you want to follow-up, please use our forum, thanks,
Yes, by giving the (observed) contango, it implies the other factors (lease rate) are incorporated such that the forward curve = Spot*exp(4%*T), for example if assume continuous
Great question. I posted it to our forum (daily FRM Fun) where me and 2 others gave our detailed answer. My short version is that under a theory of normal, the S(t) is uncertain (volatile) such that F(0) must be < E[S(t)] due to risk aversion
Finally got cleared my doubts... after watching this video... thanks..
How I wish I had a prof like you David.. Thank you!
so, Normal curve = contango.... Inverted curve = backwardation.
:) Im glad I watched this link, made it easier to understand
Nice video. Crystal clear
you explain it the way Nobody Else has😍
+13traders Thank you! We are happy to hear that our videos are so helpful. Thanks for watching!
true I agree
I absolutely agree. I have never seen it explained so easily like this before! Thank you! Really helpful!
@admetric nice to hear, glad i could help!
one question about oil: the graph shows backwardation so the future price is lower than the actual spot price (or at least, the near term future contract price is higher than longer term future). If I should interpret that, I'd say that operators find urgent a short term buy for oil rather than buy it in the future.But, according to convenience yield/storage costs, I thought that a oil buyer would prefer pay a higher price for the convenience of NOT paying for storage. So, they would pay a "premium" for keeping the oil in the hands of seller until the future day deliver. In that case....shouldn't be in contango???
Thanks for the lesson. I do have one question. With backwardation, as the case with crude oil recently, this would suggest that one should either hold short positions or simply dump the stock, right? However I keep hearing that this is not the case with Gold and Silvers recent backwardation. Many reports on backwardation in regards to PM's is suggesting something else (currency crisis). Why and why does it not indicate a future dump of COMEX contracts?
Excellent explanation. Thanks David.
thanks very much for this insightful video. I was wondering if u could if you could share ur views on this scenario. I am working on an assignment involving contangos. What does it mean if we say: the current gold spot price is $300/oz and the current forward contango is 4% nominal per annum. Does it imply an increase in 4% of the current spot price to give us our forward prices?
Will expect ur reply soon
Thank you... very informative and easy to understand video
not necessarily a deficit. If you look at the tremendous amount of speculative buyers of commodity futures, the signal could be wholly driven by some sort of non-agricultural market factors. From simple things like "my hedge fund bought 10 billion dollars worth of gas futures and now the price is tanking, forcing me to liquidate these positions, driving them further down' to 'Russia closed its grain exports 6 months ago but the threat to their grain was a chimera and now the market is flooded.."
Very good explanation! Many thanks!!
So when silver had a price spike to $50 an ounce, and people would only buy at $35 an ounce, would that be considered contango leading to forward backwardation?
So when a market is in backwardation for, say, an agri commodity, is the market giving a signal to producers to sell now rather than later? Probably because there will be a deficit in the future? Just trying to see how this would apply in real life. Cheers.
this finally makes sense! they should change the names to something like
normal contango and abnormal contango.
Thank you for your insightful video?just one question, does future/forward prices changes continuously and price quoted by business network like bloomberg or on wall street journal are future price or spot price?
Hello Mr Harper, Could you help me to understand why in the crude oil future markets, lots of traders often trade Jun/Dec & Dec red Dec future calendar spread, are there any fundamental reasons behind this?
you sir are amazing. thank you!
Explained so well thank you very much !
why do they say Backwardation has positive roll yield?
Thanks very much. I appreciate ur efforts!
Very clear explanation. thanks
why isnt expected future spot price same as future price?
The expected futures spot price includes a risk premium in its required rate of return due to the risk-averse nature of investors. Whereas the futures price only has the risk-free rate as its required rate of return (no risk premium) due to the risk-neutral nature of pricing derivatives. This idea of risk-neutrality in derivative pricing is key. If we've already arrived at a risk-averse price for the underlying, and you're buying something that derives its value off the underlying, you should be risk-neutral at that point because the underlying is already priced out for risk-aversion.
@britoca how about "ass-backwardation" lol THINK about volatility Futures !!! we have a flash crash and the back months get backwards i.e. like options in futures trading at discount IF that makes sense -G
@acidentallycool Awesome, thanks!
the point? learning. In some subjects, people like to learn stuff, to, you know improve themselves. For example, you can even learn how to type these days :)
thanks a lot, indeed very helpful
@kristonren with exception to the alternating cycles
Great vid!!!
ongango?
thank you so much!!
Thank you
You're welcome! Thank you for watching!
Backwardation!! : P I'm gonna stick that in conversation any chance I get haha
cheers ^^ this cleared up a few things :D
DUDE! YES!
Seems like a nice guy but he immediately turned me off. A futures term structure curve is not "in" backwardation or contango. The curves are either inverted or not. If they are inverted they "anticipate" backwardation" and anticipate contango if the curve is rising between two dates. In that sense, contango and backwardation are kind of verbs and not nouns, per se.
It is just one of those things that is really hard for my simple brain to deal with...doooh