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The graph of the "life of a single futures contract" (as shown above on the right) will show it converging towards the spot price.
The contango contract for future delivery, selling today, is at a price premium relative to buying the commodity today and taking delivery.
"normal"), since contracts for further dates would typically trade at even higher prices.
(The curves in question plot market prices for various contracts at different maturities — cf.
The graph depicts how the price of a single forward contract will typically behave through time in relation to the expected future price at any point in time.
A futures contract in contango will normally decrease in value until it equals the spot price of the underlying at maturity.
Such costs include warehousing fees and interest forgone on money tied up (or the time-value-of money, etc.), less income from leasing out the commodity if possible (e.g. A normal forward curve depicting the prices of multiple contracts, all for the same good, but of different maturities, slopes upward.
Let us say, for example, that a forward oil contract for twelve months in the future is selling for 0 today, while today's spot price is .
This may be due to people's desire to pay a premium to have the commodity in the future rather than paying the costs of storage and carry costs of buying the commodity today." On the other side of the trade, hedgers (commodity producers and commodity holders) are happy to sell futures contracts and accept the higher-than-expected returns.
Because the normal course of a futures contract in a market in contango is to decline in price, a fund composed of such contracts buys the contracts at the high price (going forward) and closes them out later at the usually lower spot price.
The money raised from the low priced, closed out contracts will not buy the same number of new contracts going forward.
Locking in a future price puts the purchaser "first in line" for delivery even though the contract will, as it matures, converge on the spot price as shown in the graph.
In uncertain markets where end users must constantly have a certain input of a stock of goods, a combination of forward (future) and spot buying reduces uncertainty.This is favorable for investors who have long positions since they want the futures price to rise to the level of the current spot price." The Commission of the European Communities, in a report on agricultural commodity speculation, defined backwardation and contango in relation to spot prices: "The futures price may be either higher or lower than the spot price.