Unit 3 · Level 3 · Futures & perps
Basis, contango and the roll
Spot is the price of the thing NOW; the future is the price of the thing LATER, and the gap between them is the basis. Usually futures sit above spot (carry costs: storage, financing) and later expiries sit higher still. That upward slope is contango. Its mirror is backwardation: near contracts above far, scarcity NOW. Neither is a prediction; both are a cost structure.
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What you get asked
'Contango' describes a market where…
An upward-sloping futures curve, usually reflecting the cost of carrying the asset through time. Backwardation is the inverted case.
Why do futures USUALLY trade above spot?
If futures were cheaper than spot plus carry, arbitrageurs would buy the future, short the spot, and pocket the difference. So carry, not mood, sets the usual gap.
Match the term to its meaning
Futures expire; exposure that must persist gets 'rolled' to the next contract, and the shape of the curve decides what that ride costs.
In contango, rolling a long position month after month means repeatedly buying dearer contracts, a steady ___ on returns.
Each roll sells the cheap expiring contract and buys the pricier next one. Small each month, brutal compounded: the quiet killer of 'buy and hold the future'.
In April 2020 the front-month WTI oil future settled near −$37 while long-oil funds bled for months on rolls. The deeper lesson?
Traders with nowhere to store oil paid to escape delivery: a futures-market fact, not a statement about oil's worth. Curve shape and roll cost ARE the product when you hold futures. 🐜
The rest of this unit
Obligations, basis, funding and hedges: the contracts professionals run on.