if I remember correctly, is contango , actual price higher than expected price, and backwardation the opposite ? Thanks.
Contango - futures above spot Backwardation - futures below spot Normal Contango - futures above expected spot Normal Backwardation - futures below expected spot
Here’s a question: Can normal contango or normal backwardation exist approaching expected spot? Isn’t it a rule that futures and expected spot must converge?
they can exist but the basis is decreasing
If the future price is approaching the spot price…this is implying that F< expected spot…so means normal backwardation?
I think there was a question on convergence in one of the sample tests asking and I totally screwed it up because I was thinking of normal contango…
kellyc319 Wrote: ------------------------------------------------------- > If the future price is approaching the spot > price…this is implying that F< expected > spot…so means normal backwardation? future price can approach the spot price from downwards or upwards. depends on the side the hedgers and speculators are (long or short)
this stuff is still confusing to me, but I think future price and spot price should converge at the the expiration time otherwise there will be an arbitrage opportunity?
CFAHouston Wrote: ------------------------------------------------------- > this stuff is still confusing to me, but I think > future price and spot price should converge at the > the expiration time otherwise there will be an > arbitrage opportunity? fo sho what is confusing you?
the whole passing of risk from asset relative to normal contango/normal backwardation.
there is no arbitrage opp. cos the speculator take the hedger’s risk
so do common financial assets like futures on bonds and stocks trade “usually” in backwardation or normal backwardation?
think it in this way: if you are a hedger, u have to sell the product at a lower price than the expected spot, -> normal backwardation similarly, u have to buy at higher than expected spot, normal contago
good put, aeolusloo. So, when speculators > hedgers, normal contango. Hedgers > speculators, normal backwadation?
That makes sense to me gz2nyc…i was confused until now thanks! So somone confirm that this is indeed true? if there are more speculators…buy a bunch of futures which drives future prices up so F>S = cantango. and vice versa.
the side that the speculators are needs more reward speculator long - future prices need to be lower than expected (otherwise no reward for being long) - backwardation speculator short - future prices need to be higher than expected ( speculators want to sell high and buy lower in the spot market for ex) - contango so always speculator will have a better prices than what is expected - lower if he is long, higher if he is short hope it makes sense
That theory that speculators are compensated for taking on risk just doesn’t have much empirical support. In particular, 95% of players in futures markets are speculators (except they may be “hedging” things like swaps positions - we got out of contract limits onLIBOR contracts by saying we were hedgers because we had lots of positions in ED contracts. Didn’t even matter that they were the same direction). Anyway, the relationship between financial futures and spots is almost always a simple formula and an arbitrage relationship. The issue of whether expected spot > futures price is about whether the expected return from the underlier > risk-free rate. Normally, you would expect it to be and you would be up considerable money over time by taking a long position in every financial future and rolling it forward. Buy and hold works and it works in futures contracts in a tax inefficient way in the US (works better in Japan than buy and hold underlier). Except in unusual circumstance futures -> spot at least if you take into account all the stuff that happens during delivery. You can’t really say that futures -> expected spot unless you are just saying that expected spot = spot at expiration.