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FRM Part I · FRM Exam Part I · Commodity Forwards and Futures

A commodity trader observes that the futures price for crude oil for delivery in six months is USD 82, while the spot price is USD 78. Which description of the market is correct?

The market is in contango, because the six-month futures price of USD 82 is above the spot price of USD 78. Contango means an upward-sloping futures curve with futures above spot, while backwardation is the opposite, with futures priced below spot.

  1. AThe market is in contango because the futures price exceeds the spot priceCorrect
  2. BThe market is in backwardation because the futures price exceeds the spot price
  3. CThe market is in contango because the spot price is below the expected spot price
  4. DThe market is in backwardation because the futures curve is upward sloping

Explanation

Contango is defined as a futures curve in which futures prices are above spot and rise with maturity. Here 82 > 78, so the market is in contango. Backwardation would require futures below spot, so the second and fourth options misuse the term.

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