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Current time:0:00Total duration:3:44

Video transcript

let's do a quick review of contango and backwardation because they really are opposites of each other but they're used in different contexts sometimes with the exact right meetings sometimes with the not so right meeting so let's clarify what we're talking about so if you hear a commodities traders say that a market is in contango they're normally just referring to the fact that you have an upward sloping futures curve so what would technically be just you call it a normal futures curve because it's upward sloping they would call it contango it sounds a little fancier and if you were to hear commodities traders today that a market is in backwardation they're really just talking about an inverted futures curve they're just talking about something like this now if we were to be more precise with those that's how it's used in kind of common everyday lingo but if you wanted to be more precise if someone were to talk tell you that we're to talk about contango theory contango theory maybe in an academic setting then they're talking about the notion that the future delivery price is actually higher than what people expect the price to be at that date the problem with that is it's just a theory and there's no way to know ahead of time what that expected price actually was so it's very theoretical similarly if someone is talking about backwardation theory or even I guess more particularly if they use the word normal backwardation if they say the theory of normal backwardation they just don't say backwardation by itself they say the theory of normal backwardation they're talking about the idea that the future delivery price is lower than some expected price because these the seller is willing to sell the discount so that they can essentially lock their prices in but once again it's a very theoretical idea it's really hard to observe it in the real world because you actually don't know what the expected price is so someone is saying backwardation they're usually just talking about it inverted and inverted futures curve if someone talks about normal backwardation or the theory of normal backwardation they're talking about the idea that the future price the future delivery price is below the markets expected price I've even seen the word normal can Kengo used when they're talking about contango theory the idea that the future price would be above the expected price so contango theory is the opposite of the theory of normal backwardation now for both of the theories you never know what this expected price is so you can't literally observe it a snapshot in real time and the closest thing we can do to observing either a real contango in a market or real normal backwardation in a market is if in the example of contango if the future delivery price right now is higher than the expected as we get closer and closer to that delivery date it should converge or it should move down so you can kind of observe contango over time when this price moves down as we go forward in time this is a snapshot this is it moving in down moving down as we move ahead in time same thing for normal backwardation the only way that you can really observe it or even attempt to observe it is to look at what happens to this price over time in eight months the delivery price is 50 dollars but as we move future as we move forward in time and that contract becomes closer and closer to its actual delivery date it will converge with the spot price and it will move up so this observation of the few of the futures price moving up as you get closer to delivery some that's a better way of observing that a market is experiencing normal backwardation hopefully that clarifies some things