Which statement correctly distinguishes contango from backwardation?​ 

Solution

Contango and backwardation describe the relationship between a commodity's current spot price and its future price, indicating market sentiment and cost structures. Contango occurs when futures prices are higher than the spot price, often due to storage/carrying costs. Backwardation happens when futures prices are lower than the spot price, typically signaling supply shortages or high immediate demand.   Contango (Upward Sloping Curve): Here, the Future price > spot price. It often reflects a normal market state where the cost of carry (storage, insurance, financing) is included. It reflects market expectations of a higher spot price in the future. The higher price in future maybe due to higher carrying costs, not necessarily because of a supply-demand crisis. As such, it does not necessarily mean bullish sentiment. Contango can be disadvantageous for traders holding long futures positions (or ETFs) that must "roll" to later, more expensive contracts.  Backwardation (Downward Sloping Curve): Here Future Price < Spot Price. It typically occurs due to strong immediate demand, low supply, or market shocks. It reflects a bullish spot market but sometimes suggests lower prices later, or an expectation that the immediate scarcity will resolve. It can be advantageous for long-term investors ("roll yield") as cheaper future contracts are purchased.  • High convenience yield → backwardation due to scarcity value of holding the physical commodity.​  • Market expectations alone do not define curve shape.​