In contrast, if the futures price is below the expected spot price, the futures market is said to be in a state of “backwardation.”
Typically, a futures-based commodity ETF trader would benefit if the underlying commodity is trading in backwardation. Since ETFs have to roll futures to avoid physical delivery of the commodity, a fund gains a profit every time it rolls to a cheaper later-dated futures contract in a backwardated market.
In a contangoed market, the ETF loses money each time it rolls contracts to a costlier later-dated contract. Additionally, potential investors should note that in a contangoed market, futures-based commodity ETFs can experience heavy losses even if the underlying commodity’s spot price rises.
For past stories in this series, visit our “What is an ETF?” category.
Max Chen contributed to this article.