Definition of Backwardation

Backwardation is a pricing structure where futures contracts are trading at progressively lower prices to the cash market and to near term contracts. Backwardation is also known as an inverted market.

Applying "Backwardation" to Securities Exams:

During times of supply shortages the market for a given commodity may become inverted where the price of the cash commodity is trading at a premium to the futures contract prices. When this occurs, users of the commodity scramble to acquire the commodity and bid up the prices in the cash market and for the near?term futures contracts to ensure that they will have enough of the commodity to meet their needs. Th e price of the distant futures contracts is lower than the price of the near?term month contracts as the market prices in new supply and anticipates an end to the shortage. When this pricing structure occurs the market is said to be in backwardation.

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