Contango compares delivery prices today. Read the curve, distinguish spot from expected spot, and see why a higher replacement futures quote is not an immediate loss.
Contango
Contango describes a market in which a futures price exceeds the current spot price; traders also use it for an upward-sloping segment of a commodity forward curve, where a later delivery price exceeds an earlier one. State which comparison you mean. The distinction matters when choosing a hedge maturity or maintaining commodity futures exposure: a higher quote for later delivery is not an immediate trading loss or a forecast of rising spot prices.
Read across delivery dates
Consider simultaneous fictional quotes for the same underlying commodity, grade and delivery location, all in USD per unit:
Delivery
Price today
Spot
100
One-month future
103
Three-month future
107
Both futures exceed spot. The futures segment also slopes upward: the three-month quote is 4 USD per unit above the one-month quote. The three-month premium to spot is 7 USD per unit. These are different spreads.
Fictional simultaneous quotes for one commodity are spot 100, one-month futures 103 and three-month futures 107 USD per unit. The farther-minus-nearby spread is plus 4 USD per unit. These are prices across delivery dates, not a future spot-price path.
Original synthetic snapshot. Delivery dates run along the horizontal axis; all quotes are observed at the same fictional instant. The connecting line guides the eye between the three stated quotes.
One future above spot does not establish the slope of the whole curve. For example, spot 100, nearby 107 and farther 103 would put both futures above spot while the futures segment slopes downward. Seasonal curves can contain rising and falling segments. Backwardation describes the opposite comparison, so identify the maturities rather than assigning an ambiguous label to every part of a curve.
Why later delivery can cost more
For a storable commodity, supplying inventory later can require financing the purchase, paying storage and insurance, and securing delivery capacity. These costs of carry can support a premium for later delivery. Convenience yield, the operational benefit of having physical inventory available, works in the other direction. Seasonality and contract specifications also matter.
Contango alone therefore does not prove that a commodity is unwanted, that storage is available to you, or that buying physical inventory and selling futures locks in a profit. A cash-and-carry assessment must cover the full financing, storage and delivery arrangement.
The Commodities lesson, available with a free signed-in account, develops storage, convenience yield and the quantity and delivery matching needed for a physical hedge.
A higher replacement quote is not a cash loss
A futures quote is not the purchase price of physical inventory paid when the contract is opened. Margin supports the position, and subsequent settlement payments reflect price changes in the contract actually held.
Suppose a fictional long contract represents 100 units. You close the nearby contract at 103 and open the farther contract at 107. Ignore fees, collateral interest and funding costs. Over two successive holding periods, assume:
Contract held
Entry → exit, USD/unit
Cumulative trading P&L
Nearby, closed at the roll
103 → 103
USD 0
Farther, opened at the roll and closed later
107 → 107
USD 0
The roll closes the nearby position and opens a different expiry. The 4 USD per unit difference is between two contemporaneous quotes, not a settlement payment for a change in either contract. Both holdings have zero trading P&L in this illustration.
For the farther contract, cumulative long trading P&L before costs is
100×(Fexit−107).
A later exit at 109 earns USD 200; an exit at 100 loses USD 700. Entering at 107 when spot is 100 does not itself lose USD 700. A decline towards an unchanged spot price is one possible path, not something the initial curve guarantees. Commodity roll yield requires a stated holding strategy and return decomposition; total investment return also depends on collateral income, costs and the subsequent market path.
“Normal contango” asks a different question
In expected-spot terminology, normal contango means that today's futures price exceeds the expected spot price at that contract's maturity:
F(t,T)>EtP[ST].
Here P denotes the physical, real-world probability model. This expectation is an estimate, not an observed quote. Terminology varies: Hull also uses “contango” for this expected-spot comparison, while exchange explanations commonly compare futures with current spot. Check the stated benchmark.
In the original snapshot, suppose the assumed expected three-month spot price were 110 USD per unit. The future at 107 would exceed today's spot of 100 yet lie below expected terminal spot. The spot comparison indicates contango, while the expected-spot comparison indicates normal backwardation. Neither assumption identifies what the realised spot price will be.
John C. Hull, Options, Futures, and Other Derivatives, ninth Global Edition, Pearson, 2018, §§5.11–5.14, pp. 143–148: commodity carrying costs, convenience yield and the distinction between futures prices and expected future spot prices. All numerical examples and the figure here are original and fictional.
