Contango, Backwardation and Roll Yield: Why Futures Charts Differ From Spot

Contango is when later futures months are priced above nearer months, an upward-sloping curve; backwardation is when later months are cheaper. If you hold a long position and keep rolling it, contango costs you money and backwardation pays you, even when the spot price does not move: this is called roll yield. It explains why a long-run chart of a rolled futures position, or a futures-based ETF, can look very different from the spot price.

The futures curve

Line up the prices of every delivery month and you get the futures curve (also called the term structure).

Month	Contango example (crude)	Backwardation example (crude)
January (front)	$80.00	$80.00
February	$80.60	$79.30
March	$81.10	$78.70
April	$81.50	$78.20

The shape of the curve is information. It tells you how the market values oil now compared with oil later.

Why contango happens

Holding a physical commodity costs money: storage, insurance and the interest you could have earned on the cash. If there is plenty of supply, nobody needs the goods urgently, so later delivery must be priced higher to pay for that cost of carry. Gold is almost always in mild contango, roughly in line with interest rates. Oil moves into steep contango when inventories are overflowing; in early 2020 storage filled so fast that the curve became extremely steep, a condition traders call "super contango".

Why backwardation happens

When a commodity is scarce right now, refiners, mills and factories will pay extra to have it today rather than later. This benefit of holding physical stock is called the convenience yield. When it is larger than the cost of carry, near months trade above later months. Crude oil has often been in backwardation when inventories were tight, and grains can flip into backwardation before a harvest if old-crop stocks run low.

Roll yield, worked out

Example (contango): Spot crude is $80.00 and the next contract, February, is $80.60. You buy February. If spot stays at $80.00, February converges to about $80.00 by expiry and you lose $0.60, or 0.60 / 80.60 = about 0.74%, in a month in which "oil did not move". If that repeated every month, a year of rolling would leave you with about 91.4% of your starting value, a loss of roughly 8.6%, with a perfectly flat spot price.

Example (backwardation): Spot is $80.00 and February is $79.30. You buy February. If spot stays at $80.00, February rises towards $80.00 and you gain $0.70, about 0.88%, from the roll alone.

So the total return of a long futures position has three parts:

1. Spot return: the change in the underlying spot price.
2. Roll yield: the gain or loss from contracts converging towards spot and being rolled.
3. Collateral yield: interest earned on the cash not used as margin.

A short position sees the mirror image: shorts earn roll yield in contango and pay it in backwardation. This is one reason long and short trades in commodities behave differently, a theme in the trend-following lesson.

Where roll yield hits real investors

Futures-based ETFs must keep rolling, so in long periods of contango they can trail the spot price badly. Natural gas is the classic case: its curve spends much of each year in contango, and long-only funds that rolled natural gas futures fell far behind the spot price over the 2010s. Physically backed gold funds do not roll at all, so they track spot minus a fee.

Continuous contracts: how long charts are built

A single futures contract only trades for a limited time, so long-term charts stitch many contracts together. There are three common methods.

1. Unadjusted (nearest futures)

Prices are simply joined at each roll. Old prices are real, but the chart shows an artificial jump on every roll date, which can trigger false breakouts and stops in a backtest.

2. Back-adjusted (difference method)

At each roll, the gap between the new and old contract is added to all earlier prices, removing the jump. The latest prices equal the current contract, and point-by-point moves on the chart match what a rolling trader actually earned. But older price levels are no longer real.

3. Ratio-adjusted

At each roll, earlier prices are multiplied by the ratio of the new to the old contract (82.40 / 82.00 in the example). Percentage moves are preserved, which suits percentage-based indicators and returns, but old levels are again not the real historical prices.

DanioX's commodity pages explain their own approach: the jump at each roll is removed by scaling the older history, so today's price is the real quote and older prices are on today's contract basis. You can see this on the commodity market charts.

Why a long-run futures chart differs from spot

Because an adjusted continuous chart builds in every roll gap, it shows the return of holding futures and rolling them, not the spot price. In a market that spent years in contango, the adjusted chart rises less (or falls more) than spot, because the long kept paying to roll. In a market that spent years in backwardation, the adjusted chart rises more than spot. For gold, the adjusted futures chart rises a little less than spot over time, roughly by the financing cost built into the curve, which an investor would earn back as interest on unused cash.

What this means for your trading

• Use adjusted continuous data for indicators and signals, and measure profits in points or money per contract.
• Do not use old adjusted levels for rules like "buy oil below $40": that $40 may never have traded.
• For percentage-based statistics, prefer ratio-adjusted data or real contract prices.
• Before holding any rolled position for months, check whether the curve is in contango or backwardation.