Backwardation
Backwardation is when the current price of an underlying asset is higher than prices trading in the futures market. It can occur as a result of a higher demand for an asset currently than the contracts maturing in the coming months through the futures market. Traders use backwardation to make a profit by selling short at the current price and buy at the lower futures price.
Pros
- Backwardation can be beneficial to speculators and short-term traders wishing to gain from arbitrage.
- Backwardation can be used as a leading indicator signaling that spot prices will fall in the future.
Cons
- Investors can lose money from backwardation if futures prices continue to move lower.
- Trading backwardation due to a commodity shortage can lead to losses if new suppliers come online to boost production.