In our last discussion, we explored the concept of lending and walked through an example of selling March and buying April. This time, let’s dive into what happens when the market is in contango, a situation where prices for future contracts are higher than nearby prices.
What is Contango?
Simply put, contango occurs when the future price of a commodity (e.g., April) is higher than its current or nearby price (e.g., March). This price curve reflects expectations of higher costs in the future, driven by factors like storage, insurance, or market sentiment.
The March-April Scenario
Now, imagine you’re selling March and buying April. In a contango scenario:
April prices are higher than March prices.
If you are long in March and need to stay long in April, selling March and buying April will result in a loss because you’re buying at a higher price.
For example, in the aluminium market, a typical contango spread (cash-to-threes) might be $30 or more. But recently, this spread narrowed to just $7. The cost of contango—and your potential loss—depends heavily on the size of this spread. A smaller contango means lower costs, while a wider contango increases the financial burden.
Is This Good or Bad?
The answer depends on your trading strategy and market conditions. Contango isn’t inherently good or bad—it’s simply a market dynamic you need to account for when planning your trades.
What’s Next?
We’re only scratching the surface of lending and contango dynamics. In our next session, we’ll dive deeper into this topic and explore strategies to navigate these situations effectively.
Stay tuned for more insights, and let’s continue mastering the complexities of aluminium trading!