From Traderpedia

Definition: Contango is a futures market term. It is the situation where, and the amount by which, the price of a commodity for future delivery is higher than the Spot price. Or a far future delivery price higher than a nearer future delivery. A contango is normal for a non-perishable commodity which has a cost of carry. Such costs include warehousing fees and interest forgone on money tied up, less income from leasing out the commodity if possible (eg. gold).

Markets for non-perishable goods may also exist in a state of contango. For example crude oil prices in 2006 have routinely been in a state of contango.

The contango should equal the cost of carry, because producers and consumers can compare the futures contract price against the spot price plus storage, and choose the better one. Arbitrageurs can sell one and buy the other for a risk-free profit too (see rational pricing – futures).

If there is a near-term shortage, the price comparison breaks down and contango may be reduced or perhaps even reverse altogether into a state called backwardation. In that state, near prices become higher than far prices because for consumers future delivery does not suffice, and because there are few holders who can make an arbitrage profit by selling the spot and buying back the future. A market that is steeply backwardated--i.e., one where there is a very steep premium for material available for immediate delivery--often indicates a perception of shortage in the underlying commodity. By the same token, a market that is deeply in contango may indicate a perception of supply surplus in the commodity.

For perishable commodities, price differences between near and far delivery are not a contango. Different delivery dates are like different commodities in this case, since fresh eggs today are not fresh in 6 months time, or 90-day treasury bills will expire, etc.

[edit] See also

• Backwardation