Get started

Contango

Trading Strategies for Capitalizing on the Volatility of OilAs financial market traders, we are always on the lookout for trading strategies that can help us capitalize on market trends and conditions. One such strategy is to take advantage of the volatility of oil prices. Oil is a valuable commodity that is subject to significant price fluctuations. There are several reasons why oil is volatile, including limited supply, high demand, geopolitical instability, and speculation. These factors can cause the price of oil to fluctuate rapidly and often unpredictably, which can create opportunities for traders who are able to anticipate and capitalize on changes in the price of oil. One way to take advantage of the volatility of oil prices is to use a trading strategy known as "contango trading." Contango trading involves buying oil futures contracts and holding them until they mature. When the price of oil is in contango (i.e. when the futures price is higher than the spot price), traders can profit by buying the futures contracts and holding them until they mature. This allows traders to take advantage of the difference between the spot price and the futures price, and can provide an attractive return on investment if the price of oil rises as expected. Another way to take advantage of the volatility of oil prices is to use a trading strategy known as "spread trading." Spread trading involves buying and selling oil futures contracts with different expiration dates. When the price of oil is volatile, the prices of different futures contracts can diverge, creating opportunities for traders to profit by buying and selling these contracts. For example, if a trader expects the price of oil to rise in the short term but fall in the long term, they may choose to buy a short-term futures contract and sell a long-term contract. If their prediction is correct, they could profit from the difference in the prices of the two contracts. Overall, the volatility of oil prices can create opportunities for traders who are able to anticipate and capitalize on changes in the price of oil. By using strategies such as contango trading and spread trading, traders can potentially profit from the volatility of oil prices and generate attractive returns on their investments. In Depth Contango Trading - This strategy is based on the expectation that the price of oil will rise over time, and it is used by traders who want to capitalize on this expected price increase. When the price of oil is in contango, it means that the futures price is higher than the spot price. For example, if the current spot price of oil is $50 per barrel, and the futures price for oil to be delivered in six months is $55 per barrel, then the price of oil is in contango. In this situation, traders who use contango trading would buy the futures contracts and hold them until they mature, hoping to profit from the expected increase in the price of oil. The profit from contango trading is the difference between the spot price and the futures price. In the example above, a trader who buys the futures contract at $55 per barrel and holds it until it matures would make a profit of $5 per barrel if the price of oil remains at $50 per barrel. If the price of oil increases above $55 per barrel, then the trader's profit would be even greater. Contango trading is a risky strategy, as it is based on the expectation that the price of oil will rise over time. If the price of oil does not rise as expected, or if it falls, then traders who use contango trading could suffer significant losses. Additionally, the volatility of oil prices means that it can be difficult to predict the direction of price changes, which can also create risks for traders who use this strategy.
FX:USOILEducation
by JoelWarby
Term Structure Provides Fundamental CluesLast week, I wrote on processing spreads, a valuable tool that can provide clues about price direction. The price action in products that trade in the futures market like gasoline, heating oil, soybean meal, and soybean oil often tell us a lot about the path of least resistance for the crude oil and soybean futures contracts. This week, I will turn my attention to term structure. Term structure is the price differential between one delivery period and another in the same commodity. Some traders call term structure time spreads, calendar spreads, front-to-back spreads, or switches. They are all the same, reflecting delivery or settlement premiums or discounts based only on time. Backwardation- It’s what it sounds like Contango- It’s not what it sounds like A real-time supply and demand indicator Commodities are unique- A mentor made a mint trading time spreads Time spreads can enhance your commodity trading results- The cure for low and high commodity prices The late Apple founder Steve Jobs once said, “My favorite things in life don’t cost any money. It’s really clear that the most precious resource we all have is time.” While Steve Jobs was referring to his mortality, time is a critical factor in commodities. Close attention to term structure unlocks clues about fundamental supply and demand factors. Backwardation- It’s what it sounds like Backwardation is a condition where commodity prices for deferred delivery are lower than for nearby delivery. A backwardation suggests that supplies are tight, forcing nearby prices higher. The condition also indicates that producers will increase output in response to a market’s deficit, leading to lower future markets. As of the end of last week, the NYMEX crude oil futures market was in backwardation. The chart of NYMEX WTI crude oil for delivery in December 2022 minus the price for delivery in December 2021 was trading at over a $12 per barrel backwardation or discount. December 2021 futures settled at the $83.57 level on October 29, with the December 2022 futures at the $71.33 level. Robust demand, supply concerns, and other factors have driven the spread into the widest backwardation in years and NYMEX crude oil to the highest price since 2014. Higher crude oil prices tend to support a wider backwardation. Historically, the Middle East’s political volatility has caused supply concerns at higher prices as the region is home to over half the world’s petroleum reserves. Crude oil is one example of a raw material market where the term structure reflects supply concerns. The trend towards a wider backwardation has been bullish for the energy commodity. Contango- It’s not what it sounds like While backwardation is a term that reflects the spread differentials, contango is another story. In the commodities lingo world, contango is backwardation’s opposite as it reflects a market where prices for deferred delivery are higher than for nearby delivery. Backwardation is a sign of supply concerns, whereas contango is present during periods of oversupply or equilibrium where supply and demand balance. The gold futures market is an example of a term structure in contango. The daily chart highlights gold for delivery in December 2022 minus December 2021 is trading at a $10.30 contango or premium at the end of last week. The December 2021 futures were at the $1783.90 level, with the December 2022 contract at the $1794.20 level. Central banks worldwide hold massive gold stocks as part of their foreign exchange reserves. Therefore, supply concerns tend to be low in the gold markets leading to a premium in its term structure. Moreover, gold has a long history as a means of exchange or money. Higher interest rates tend to push gold contangos higher. Gold is one example of a commodity market in contango. A real-time supply and demand indicator A commodity’s term structure can be a helpful tool as it provides insight into supply and demand fundamentals. When a raw material price spikes higher because demand rises or supplies decline, the term structure tends to move into a widening backwardation. Producers respond by increasing output, creating the deferred discount. When markets are in glut or oversupply conditions, producers often cut back on output, causing the chances for future deficits to develop. Thus, a steep contango can reflect the market’s perception that nearby oversupply will lead to eventual shortages. Term structure is one of the puzzle pieces that comprise a market’s structure. The others are processing spreads, location and quality spreads, and substitution spreads. Commodities are unique- A mentor made a mint trading time spreads Commodities are essentials. Agricultural commodities feed and clothe the world and are increasingly providing alternative energy. Industrial commodities, including metals, energy, and minerals, are requirements for shelter, power, and infrastructure. Other raw materials have varying applications in daily life and even the financial system. Shortages or gluts can have significant impacts on the global economy. The current inflationary pressures have roots in commodities, which had experienced price rises since the beginning of the worldwide pandemic when short-term lows gave way to bullish price action. Supply chain bottlenecks and slowdowns or shutdowns at mines and processing facilities have put upward pressure on prices. Perhaps the most dramatic example came in the lumber futures market. The quarterly lumber futures chart shows the price explosion to a record $1711.20 high in May 2021 on the back of slowdowns and shutdown at lumber mills and supply chain bottlenecks bringing wood to consumers during a period of rising demand. When lumber reached its May high, nearby January futures were far lower. The chart shows January futures peaked at $1275 per 1,000 board feet, over $435 lower than the nearby contract at the May high. When I worked at Phibro in the 1990s, my direct boss was Andy Hall, one of the most successful crude oil traders in history. While many market participants believe Mr. Hall churned out profits with long and short positions in the oil market, his greatest success came from what he called “structural risk positions.” He tended to buy the front months in the oil market and sell the deferred contracts when the market moved into contango. I remember the night when Saddam Hussein marched into Kuwait in 1990. The invasion caused the nearby price of crude oil to double in a matter of minutes. Meanwhile, deferred oil prices declined, sending the spread to a massive backwardation. Mr. Hall pocketed hundreds of millions in profits on that night. His theory was that the risk of contango was limited over time, and the potential for spikes in backwardation increased the odds of success. Time spreads can enhance your commodity trading results- The cure for low and high commodity prices Commodity prices tend to rise to prices where producers increase output, consumers look for substitutes or limit buying, causing inventories to build. As supply rise to levels above demand, price find tops and reverse. Conversely, prices tend to drop to levels where production becomes uneconomic. At low prices, consumers look to increase buying, and inventories decline, leading to price bottoms and upside reversals. The cure for high or low prices is those high or low prices in the world of commodities. Meanwhile, highs or lows can be moving targets. As we learned in lumber and a host of other markets over the years, highs occur at levels that most analysts believe are illogical, irrational, and unreasonable. We learned the same holds on the downside as nearby NYMEX crude oil futures fell to a low of negative $40.32 per barrel in April 2020. Time spreads can be real-time indicators of changes in a commodity’s supply and demand fundamentals. Understanding and monitoring term structure can only enhance the odds of success in the commodities asset class. --- Register for the Monday Night Call below. You can also sign up to see the full articles for free, and get early access, using the other link below. Trading advice given in this communication, if any, is based on information taken from trades and statistical services and other sources that we believe are reliable. The author does not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects the author’s good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice the author provides will result in profitable trades. There is risk of loss in all futures and options trading. Any investment involves substantial risks, including, but not limited to, pricing volatility, inadequate liquidity, and the potential complete loss of principal. This article does not in any way constitute an offer or solicitation of an offer to buy or sell any investment, security, or commodity discussed herein, or any security in any jurisdiction in which such an offer would be unlawful under the securities laws of such jurisdiction.
Editors' picks
LEducation
by Andy_Hecht
9
XBTZ19 Data Capture, 6 months of Bitcoin Futures dataIn my experience Tradingview does not keep data of expired Bitmex contracts after expiration. The primary purpose of this post is to keep the valuable data from XBTZ19 contract from being lost forever. My indicator script XBT Contango Calculator Version 3 is used in this example to capture all the data from the December Futures contract. This post should be a historical record of how backwardation and contango affected price action during the last 6 months. I will do this post at each expiration, primarily for my own benefit and analysis, but also as a record other traders in the community can look back on. Please also see below "Links to related Ideas"
BITMEX:XBTEducation
by SchamBTC
XBT Dancing the Contango and Farewell to XBTU19 data?This idea is to expand on my recent observations while trading Basis (spread) of futures contracts for XBT, and how recently Contango and Backwardation have been a good timing indicator for XBTUSD. For more detailed explanation, please check out my indicator script the XBT Contango Calculator in related link. Typically I have noticed that Futures premium/discount primarily flow along with price movements. For example, when price goes up, premium goes up and vis-versa. However, what i found most interesting over the last few weeks is there was a divergence in XBTUSD price and XBTZ19 futures premium (blue line), which i noticed for the first time. Additionally, this happened right before the BREAK See below A primary objective of this post, is to see if publishing this idea in Tradingview will keep the XBTU19 data (orange line) plotted by the XBT Contango Calculator. I have found that charts of expired Bitmex Futures are not available on Tradingview after expiration. Studying XBTU19 September futures has been very useful for trading over the last few months and hope this post will stand as a record on how Contango and Backwardation in XBTU19 contact affected price action (assuming data doesn't disappear after 9/27). If anyone knows a way to plot historical Bitmex data, please help me out. I believe it can be pulled via API from the following link, but I am not able to figure it out. www.bitmex.com THE FOLLOWING ARE TWO REASONS WHY I WANT TO STUDY HISTORICAL DATA FROM PREVIOUS BITMEX FUTURE CURVES. I think both of these scenarios could represent the two directions we have at the current moment. As you will see, if past futures curve data was available from these time periods, it could be helpful in deciding which direction to trade. EXHIBIT A - Mid November 2018, price drop after consolidation triangle EXHIBIT B - Mid July 2017, price pullback and continuation after consolidation triangle Let me know your thoughts?
BITMEX:BTCUSD.PEducation
by SchamBTC
7
What is backwardation?Hello all, I've been doing a lot of educational posts lately, because price has just been static. For your knowledge, I am still long on bitcoin and believe the bottom is in, but I would like to talk about something that was bullish that does not exist today: backwardation. Backwardation is an economic phenomenon proposed by John Maynard Keynes decades ago in his publication, Treatise on Money . Backwardation is when the futures price of some asset is trading lower than the spot price. What are the implications of this? Well, let's put on our thinking caps for a moment and try to understand economics (something I implore you all to try and do). If something is more expensive now than it will be in the future, that simply means it is more demanded NOW than later (or sudden decrease in supply or both). People are not wanting to wait for something, they want it right now. This is very notable in commodities like oil when sometimes there is a short-term shortage that will be gone later. I live in Texas, and we have hurricanes regularly. When this happens, you will always see gas stations filled with people who are trying to fill up cans of oil so they can leave and not stop for gas because it might not be an option in the near future. This would be an example where backwardation is occurring. This is why it is a bullish phenomenon. It's telling you that for some reason, the commodity is in great demand now. This was happening in bitcoin for quite some time, but is not happening today. Is it bearish? Not exactly, we don't have the full scope. Technically, based on the economic theory, it is neutral. The inverse of backwardation would be, you guessed it, "forwardation" or as is usually called "contango." Contango would be a bearish scenario. Perhaps I will write another article on this later in the future. But, to understand it, you simply work in reverse. Instead of a shortage, you have a surplus etc. Logic is the same. I hope you all learned something by reading this! Understanding economics and game theory is the best skillset you can have to be a thoughtful trader or entrepreneur. Hope this resonates with some of you and you become a student of these disciplines like me. Of course, understanding a lot more is good, but if you can understand these things, you can be the best CEO. A CEO does not NEED to know programming. A great CEO DOES need to see the big picture and how to ride the economic sea strategically. Good luck all, thanks for reading. -YoungShkreli
BITFINEX:BTCUSDEducation
by CantorTechnologies
10