Forward and futures contracts
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Contango from trader perspective
Male voiceover: If a commodities trader would tell you that a market is in Contango, they're just referring to the idea that it is cheaper today. So if we're talking about now, it's cheaper to buy that commodity on the Spot Market. It's cheaper to buy it on the Spot Market than it is to agree to buy it at some futures date or some future date using a Futures or Forward Contract. In the future, it is more expensive. It is more expensive. Let's say that that commodity is gold and I'll just make up gold prices for the sake of simplicity. This isn't the current gold prices. Let's say that today, you can go on the Spot Market and buy gold at $1,500 per ounce but if you wanted to buy gold, if you don't want the gold today and you wanna enter a Futures Contract to buy the gold, one year from now. Let's say the future is now one year later, one year from now. Instead of buying, let me write this down. This is the Spot Market. Instead of buying in the Spot Market for $1,500 an ounce, you could agree to buy it one year later, one year from now for $1,600 an ounce and so to a trader, this would be a market in Contango. What I wanna point out is that this isn't that strange of a thing because if you think about it, you have two options. If you wanna invest in gold and gold is something that you wanna invest for the long term. You're not gonna eat the gold. You're not going to use it to fuel your cars or anything like that. In the situation with gold, let's say you wanna keep gold for definitely a year but maybe many, many, many years. You have two ways of making that investment. You could take your $1,500 and buy the gold today but if you take your $1,500 and buy the gold today, you would lose the returns on that $1,500 on that cash that you could invest other places. You have the opportunity cost of the cash. So had you invested that cash some place else? And you also have to store that gold. In the case of gold storage, you have to find some place really secure and maybe you need to insure the gold. You need it so that people can't steal it and all the rest. You also have the storage cost. In general, you could save both of these costs, if you enter into the Futures Contract. Instead of just buying $1,500 of the Spot Market today, you could enter into this contract where you can definitely buy the gold one year later for $1,600 an ounce and then you could take your $1,500, and get interest on it, so that will grow and you'll also save money on the storage cost. In either way, especially for commodities like gold, precious metals, things that aren't consumable, things that people don't need immediately for consumption, it's not unusual for a market to be in Contango. Sometimes you might see a severe Contango maybe with something that is consumable. So maybe right now, oil is trading at $50 a barrel. Once again, I'm just making up the numbers and in the future, the Futures price is at $150. This is probably taking more into account than just the storage cost and the opportunity cost of your cash and this might be because there's a surplus for all oil consumption today. There's just a big glut in the market and people are just trying to dump it or there might be some type of perceived shortage in the future. So, you could think about it either way but this is very unusual. This type of severe Contango is very, very unusual. You would expect to see kind of minor ones. Things that take cost into consideration but not something like this. In something like this, you can usually arbitrage it out and make some money assuming you can store oil or you have oil to sell or buy and all the rest of that.