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Video transcript

contango can be one of the more difficult to comprehend ideas when we talk about futures markets but it's really because it's used in different contexts all the times with slightly different meanings depending on whether you're talking about someone participating in the futures market or whether whether an academic is talking about it but first let me give you the proper definition so the proper definition of contango it's actually a theory it's actually a theory and it really can't be you can't it really can't be observed and the in contango theory says that people are willing to pay more to buy a some commodity in the future than the actual expected price of that commodity so when we talk about expected price this is a very theoretical thing if you were to go and survey everyone participating in the futures market and say what what price do you think silver will be in eight months and if they all you know you took your survey and they all told you the 100% honest answer you could get this theoretical expected price and maybe that theoretical expected price is thirty three dollars so this right here is the expected price expected price of silver in the market and you can see from this futures curve right here that the eight the the delivery the silver futures contract for delivery let me expected for delivery eight months from now is trading above that it's trading above the expected price and it's probably trading above the expected price because people don't want to people who want to have silver in eight months they don't want to buy it today and have to go rent some space and store the silver and have to insure the silver and worry about someone maybe stealing the silver they'd rather just pay for premium in order for it to have to have it be delivered in the future so this is kind of the the correct academic definition of contango theory the theory that the the futures price on a future delivery date is going to be higher than what the market actually expects so people to some degree are paying a premium to have the have the delivery of the silver to have it delayed now in practice you will hear people say that a market is in contango and usually what they're talking about the usually talking about one of two things and it's and they're related but usually if they're if they're a little bit more correct about it they're talking about the idea that the futures price is on overtime going to converge downward to the actual spot price so what I've done here so this is the futures curve so this is just the price the delivery price of the different contracts going forward in time but this is the delivery price the market delivery price today right now this is how things trend over time so in magenta I have the spot price trending over time right over there and then you can see that you have the four month the the contract that's for delivery in four months today it's prices a little bit under $35 but as you approach it's actual delivery date so now we're actually moving forward in time it has to converge to the spot price otherwise people could make free money on that day and so the delivery date eight months out has to converge to the spot price eventually and so what you see is is because the because the spot price hasn't moved up a lot and you see this downward converging of the different futures price this is what people normally refer to when they say a market is in contango when you see the delivery price of a certain futures contract converge downward to the actual spot price all of these are converging downward over time so it's something that you would have to observe over time not something that you would traditionally just be able to look at a futures curve but in general when you have this you normally see that the Futurist delivery prices are higher the further out you go so you have this upward sloping futures curve so the simplest kind of analysis when people say something is in contango they'll just look at an upward sloping futures curve or a normal curve and say this is also in tango in contango but this isn't this isn't exactly right it's really these movements over time