What are contango and backwardation?

You already know that several futures of the same pair can exist at the same time – perpetual and urgent. At expiration, futures contracts will be settled at the spot price, which means that all futures contracts eventually tend to get as close as possible to the spot price. Often there are situations in which a quarterly futures trades noticeably cheaper or more expensive than the price of a spot asset.If the futures price is above the current spot price, this situation is called contango. If below – backwardation.

The concept applies to both perpetual futures and futures.

How to make money on it?

Everything is easy. We find a futures contract with a price different from the spot. The bigger the difference, the better. Convert the difference to a percentage. we divide the percentage yield at the rate convergence by the number of months before expiration. We get monthly income. If it suits us, we buy an asset on the spot, and sell it for the same volume on the futures in case of contango(futures price exceeds spot), or recalculate all the same information taking into account the cost of the short on the margin, open short on the margin for the same volume as the long on the futures with backwardation(spot price exceedes futures). At the moment when the futures and spot prices are equal, we close two positions and fix the profit. Everything is so simple.Such income can be combined with regular positions. In this case, there will be additional income in the movement of the position, if you hold it long enough.

What is calendar arbitrage?

The strategy described above is called calendar arbitrage. Everything is so simple.

Conclusion

Contango is the state of the futures price in which it exceeds the spot price. Backwardation is a state in which the spot price of an asset exceeds the futures price.

These situations can be used as additional income for your trading strategy.