Backwardation Definition

Learn more about Backwardation

Backwardation occurs when the current price of an underlying asset is higher than the prices of futures contracts trading for that asset. This phenomenon is the opposite of contango, where the futures prices are higher than the spot price. Backwardation typically arises when there is a high demand for the underlying asset in the current market compared to the expected demand in the future. This imbalance can be caused by factors such as supply disruptions, economic growth, or investor sentiment. For ETFs that track futures contracts, backwardation can have a positive impact on returns. When an ETF rolls over its futures contracts, it can sell the expiring contracts at a higher price than the price at which it initially purchased them. This can generate additional income for the ETF, which can translate into higher returns for investors. However, backwardation can also lead to higher transaction costs for ETFs. When an ETF purchases futures contracts, it must pay the higher backwardation premium. This can increase the ETF's expense ratio, which can slightly reduce its overall returns.

Related Terms

Contango, Futures