What is the difference between contango and normal backwardation in futures markets?

This is one of the trickiest nomenclature issues in CFA Level I derivatives. The confusion arises because there are two distinct frameworks: one observable, one theoretical.

Observable Curve Shapes

These describe the relationship between futures prices at different maturities and the current spot price:

Contango: Futures price > Spot price (upward-sloping futures curve)

• Common when storage costs are significant (crude oil, natural gas)
• Longer-dated futures are more expensive because they embed storage costs

Backwardation: Futures price < Spot price (downward-sloping futures curve)

• Common when there is a convenience yield from holding the physical commodity
• Occurs during supply shortages when immediate delivery is highly valued

Theoretical Frameworks (Keynes/Hicks)

These describe futures prices relative to the expected future spot price — which is unobservable:

Normal Backwardation: Futures price < Expected future spot price

• Theory: hedgers are net short, so they must offer speculators a discount (risk premium) to take the long side
• If true, long futures positions earn a positive risk premium over time

Normal Contango: Futures price > Expected future spot price

• Theory: hedgers are net long, so speculators who go short earn the premium

Why This Matters for Commodity Investors

Roll yield depends on the curve shape:

• In backwardation, rolling from an expiring contract to a cheaper longer-dated contract generates positive roll yield (buy low, sell high)
• In contango, rolling into a more expensive contract generates negative roll yield (buy high, sell low)

This is why commodity index funds often underperform the spot price during prolonged contango — they continuously lose money on the roll.

Exam tip: The CFA exam typically tests whether you can distinguish the four terms. Remember: contango/backwardation are observable from market prices; normal backwardation/normal contango are theoretical predictions about risk premia.

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