Finance 101: What Is Contango?

How much it costs to buy bitcoin now but settle in the future, vs spot prices, can provide important insights about market sentiment.

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"Contango" is a term used in the context of financial markets, particularly in commodities and futures trading. It describes a situation where the future price of a commodity or financial instrument is higher than the current spot price.

In other words, the cost of purchasing a commodity now, for delivery in the future, is more than the cost of simply buying it immediately. This typically occurs for several reasons:

  1. Storage Costs: Commodities like oil or agricultural products need to be stored until they are delivered.
  2. Carrying Costs: There may be expenses such as financing, insurance, and maintenance associated with holding a commodity until delivery.
  3. Interest Rates: It may be more costly to finance the purchase of a commodity over time, leading to higher future prices.
  4. Anticipated Supply and Demand: Traders may expect future supply to be higher or demand to decrease, making them willing to pay more for a commodity in the future compared to its current price.

The opposite of contango is "backwardation". This occurs when, the future price of a commodity is lower than the current spot price. Backwardation can occur when there is an immediate shortage of the commodity, or when market participants anticipate a decline in supply or an increase in demand in the near future.

Contango And Bitcoin Futures

Contango is present in bitcoin futures markets, since sellers typically want to charge an extra fee to delay settlement. (If they did not, they would simply sell at spot and have the use of that money immediately.)

In a normal market, BTC futures contracts generally trade at between a 5% and 10% annualized premium to the spot market.

BTC futures charts, via CoinTelegraph
Bitcoin one-month futures on Deribit and OKX, annualized premium (source: Laevitas)

CoinTelegraph notes that bitcoin's current futures premium has fallen to just 3.5%, its lowest since June. This highlights a decrease in BTC buyers using futures contracts.

The last time the futures premium was 3.5%, bitcoin was trading at $22,000. This is a downside target for many traders who watch futures data to inform their strategy.

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