Definition
Backwardation / Contango (Basis)
Contango is when a futures price trades above the spot price (positive basis) and backwardation is when it trades below (negative basis), reflecting cost of carry, dividends and market sentiment.
Indian equity index futures are usually in mild contango because the cost of carry (financing) exceeds expected dividends until expiry. Around heavy dividend periods or in bearish, deleveraging conditions, the basis can flip into backwardation, with futures trading below spot.
Arbitrageurs read the basis: rich contango invites long-cash, short-future arbitrage, while backwardation would invite the reverse if cash shorting were easy. Because Indian cash shorting is constrained, persistent backwardation can linger, making the basis a useful gauge of positioning and financing stress.
Related terms
- Cash-Futures ArbitrageCash-futures arbitrage profits from the gap between a stock's cash price and its futures price relative to fair value, capturing the cost-of-carry by holding the cash position against an offsetting futures position.
- Cost of CarryCost of carry is the net cost of holding an asset to a future date, comprising financing cost less any income, and it determines the fair-value difference between a futures price and the underlying spot price.
- Basis (Futures)Basis is the difference between the futures price and the spot price of the underlying, reflecting the cost of carry and market expectations, and it converges to zero as the contract approaches expiry.
- Reverse ArbitrageReverse arbitrage is the cash-futures arbitrage variant of shorting the cash market and buying the future when the future trades below fair value, constrained in India by limits on cash-market short selling.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.