To analyze the term structure of futures contracts, compare the prices of futures contracts with different expiry dates for the same asset. If future prices are higher than current prices, the market is in contango. If future prices are lower, it’s in backwardation. This helps traders understand market expectations, carry costs, and potential profits or risks in futures trading.

What Is the Term Structure in Futures Trading?

The term structure in futures trading refers to the relationship between the prices of futures contracts and their expiration dates. It shows how prices change for the same asset over time. This structure helps traders understand the market's expectations about future prices and make smarter trading decisions based on price trends.

What Is Contango in Futures Markets?

Contango happens when futures prices are higher than the spot price or the near-month contract. It usually reflects storage costs, interest, and other carrying costs. This structure is common in markets like oil or commodities, where holding physical goods costs money. Traders need to be cautious because contango can reduce profits when rolling over contracts.

What Is Backwardation in Futures Markets?

Backwardation is when futures prices are lower than the spot price or near-month contracts. It often signals strong current demand or supply shortages. Traders might benefit from holding positions through expiry in backwardated markets, as prices tend to move upward toward the spot rate, reducing rollover losses and sometimes giving gains.

How Do You Read a Futures Term Structure Chart?

A term structure chart plots futures prices on the Y-axis and expiry dates on the X-axis. An upward sloping curve shows contango, while a downward slope shows backwardation. By reading the curve, you can understand whether the market expects prices to rise or fall in the future. This helps with planning long or short strategies.

Why Is Term Structure Important for Traders?

The term structure helps traders identify pricing trends and rollover risks. In contango, rolling futures might lead to a loss. In backwardation, there might be profit potential. Understanding term structure allows traders to plan better, avoid hidden costs, and improve their returns by timing entries and exits more smartly.

How Does Term Structure Affect Investment Strategies?

Investors use term structure to choose the right contracts. For example, in contango, short-term trades might be safer to avoid roll losses. In backwardation, holding longer contracts might offer better returns. Understanding term structure helps with strategy selection, especially for commodity and index futures traders aiming for long-term or short-term gains.