Summary
A super contango happens when the gulf between the future prices and the expected future spot prices of a commodity are widened significantly. Even though this can be a tricky situation, traders armed with knowhow can strategically invest to make a profit. Read the blog to know more about super contango and how you can play alongside the challenging market conditions.
As a trader, you might have come across the terms Contango and Super Contango, particularly, in reference to the futures market. But you might wonder what they are. In future markets, Contango refers to a normal situation where the future prices of a commodity are higher than the expected future spot prices. This is usually indicative of the costs associated with carrying and financing the underlying asset. Super Contango, on the other hand, is an exacerbated Contango situation where the future prices of a commodity are significantly higher than the expected future spot prices. Super Contango is an extreme and unusual situation in contrast to Contango. Let us understand the reasons that bring about this change in the market.
Underlying reasons behind Super Contango
During a Super Contango, the delta between the expected future spot price and the actual future price is abnormally wide. Several factors are responsible for this gulf, including:
- Skewed market sentiment: Often, in anticipation of higher future prices, traders and speculators may end up hiking the prices of futures contracts. This leads to even higher prices of futures causing the abnormal price delta.
- High financing costs: The spread between futures and spot prices is also widened due to financing costs, for example, with high-interest rates.
- High storage costs: Limited storage capacity for commodities can make it a highly cost-intensive endeavour, leading to a Contango situation. When these costs go even further, it leads to Super Contango.
- Supply overload: When the underlying commodity is easily available, i.e., there is an oversupply, it can push the spot prices down. This means market participants are less willing to purchase the commodity in the current time for immediate delivery (spot) and instead lean toward purchasing it for future delivery (futures). This leads to a widening of the price gap or Super Contango.
Impact of Super Contango on the market and traders
Now you understand what a Super Contango is, let us discuss its implications on the market, and you, the trader.
Super contango can have a significant impact on the market as well as the trader's behaviour. The substantial price gap can present trading opportunities for those who are able to capitalise on the short-term price discrepancies between futures and spot markets. These traders might engage in strategies like spread trading or arbitrage that will help them capture profits from these abnormal price differences.
On the other hand, Super Contango situations may also discourage traders from holding long-term futures positions. This is because the profits may get eroded with the cost of rolling over contracts to avoid delivery. Moreover, it can also make short-term commodity investments less attractive as the expected returns may not justify the costs associated with contango. Depending on what your trading strategies are, Super Contango can thus both be an opportunity and a risk.
Making the most out of a Super Contango
As you have undoubtedly inferred, trading in a Super Contango situation is an inherently risky endeavour. However, even though profits are not guaranteed, a few tips can still help traders willing to make the most of it:
- Understanding the market dynamics: This is critical for any scenario, more so in challenging situations like Super Contango. Get a firm grasp on the specific factors causing the super contango- whether due to oversupply, high storage costs, or something else. You can only make informed trading decisions by understanding the underlying dynamics,.
- Staying updated: Always stay up to date with news and events that have an impact on the commodity you are trading. From geopolitical events to supply and demand data, and to economic reports, knowledge is your friend and ally in this endeavour.
- Examining your trading strategy: It’s time to evaluate your end goals. Are you looking to hold positions in the longer term? Or are you simply looking for short-term profit? Either way, you must customise your strategy to the specific conditions of the market during a Super Contango.
- Managing risks effectively: It doesn’t need to be repeated that Super Contango situations add volatility to the market. You must, therefore, set stop-loss orders and implement other stringent risk management strategies to limit your potential losses.
- Looking for arbitrage opportunities: You should consider shorting the futures contracts and buying the underlying commodity in the spot market if future prices are substantially higher than the expected spot prices. This will help you profit from the price convergence. Finding opportunities to arbitrage between the futures and spot markets will be an assured way of making profits.
- Monitoring continuously: Super Contango positions are hardly stable and are prone to rapid shifts. This makes it critical to stay vigilant and monitor continuously so you can adapt to the market and adjust your positions.
Drawing conclusions
Trading in a super contango market is an inherently risky proposition due to its inherent nature. However, with careful analysis, focus, and adaptation to changing market conditions, you can still venture into profitable futures trading. For new traders, consulting with an experienced financial advisor, particularly during challenging super contango situations can be the key to trading success.