Contango in Commodity Markets

C

In commodity markets, contango refers to a situation where the futures price of a commodity is higher than the spot price. This means that the expected future price of the commodity is higher than its current price.

To understand contango, it's important to understand the concepts of spot price and futures price:

1. Spot Price: The spot price, also known as the cash price or current price, is the price at which a commodity can be bought or sold for immediate delivery. It represents the current market value of the commodity.

2. Futures Price: The futures price is the price at which a commodity can be bought or sold for delivery at a future date. Futures contracts are standardized agreements to buy or sell a specific quantity of a commodity at a predetermined price and future date.

Now, let's analyze the options provided:

A. the spot price is higher than the futures price. This statement describes a situation called backwardation, not contango. Backwardation occurs when the spot price is higher than the futures price, indicating that the market expects the price of the commodity to decrease in the future.

B. the spot price is equal to the futures price. This situation is known as a flat or normal market. In a normal market, the spot price and the futures price are equal, indicating that there is no cost of carry involved. The cost of carry refers to the expenses incurred for storing the commodity, such as warehousing costs and insurance.

C. the spot price is lower than the futures price. This option correctly describes contango. In a contango market, the futures price is higher than the spot price. This situation typically arises when there is an expectation of rising prices in the future. It indicates that investors are willing to pay a premium to secure the commodity at a later date when they anticipate its price to increase. The contango market structure reflects the cost of carry, including storage costs and financing charges for holding the commodity until the delivery date.

Therefore, the correct answer is C. the spot price is lower than the futures price, indicating a contango market.