Backwardation

[jxntntrader]

Hello. Could someone please explain the term backwardation, and exactly which markets do you expect to see it in. I think I know what it means, but I am not sure if I expect to find it in certain markets such as cattle and hogs. Also, what should I be looking for that would be helpful in determining whether to enter a particular spread trade.

Thanks for any help.

Jxntntrader

[Jordan_Andy]

Backwardation...here we go.

In several markets you can buy a product today, store it away and re-deliver it later. The costs to store the product are called carrying charges (storage, insurance and financing). Because of the carrying charges it is a "normal" market situation the futures for the back month are trading higher then futures for the near month.

Because of different market situation (supply, demand) it is possible the near month is trading higher as the back month. In this case we call it backwardation or inverted market.

Andy

[jxntntrader]

Andy, thank you for your reply.

Now, take for example the current Lean Hogs contracts. Backwardation exists for the April, May and June contracts. The May and June contracts are priced higher than the previous respective month's contract. Starting with July, however, the contracts prices begin to decrease until you reach the February '07 contract, which is probably meaningless given that Friday's volume was only 15 contracts traded. Is there a "message" of some type that the market is telling me in this situation ? And, if so, is there any caution a trader should take entering into a LH spread trade at this point ?? (I am not even taking into consideration volume at this point).

Now consider the Live Cattle contracts. At this point the market is in "contango" (I believe that is the correct term -> please correct me if I'm wrong)... at least until you reach the November contract. How would you answer the same questions as above ?

Thanks for any help.

Jxntntrader

[Jordan_Andy]

Well jxntntrader....almost

Carrying charges in the futures market apply only to commodieties wich are storable, deliveragle, and redeliverable like

Wheat, Corn, Soybeans, Soy Oil, Energies...

Commodities which do not have carrying charges (because they are not storable and can not be redelivered) are

Live Cattle, Live Hogs, Feeder Cattle

There are some markets in between like Soy Meal.

Therefore you can not talk about a normal or inverted situation in the Cattles or Hogs.

Take care
Andy

[Jordan_Andy]

jxntntrader...it's me again.

After talking to Joe it seems there are different definition about backwardation or inverted markets. Joe did tell me the following:

"When Feed Lots cannot get the price they want they often hold back causing a shortage and backwardation."

When you look thru different spread charts you will find out the following: For some spreads it is "normal" to trade most of the time in backwardation others don't. Backwardation does not automatically mean there is something unusual goin on. You will find the same situation also with wheat especially when you look into spreads with legs in a different crop year.

When I look at a spread chart I always look at a historcal monthly chart as well to see "where is my spread trading right now". Is it trading "normal" or is it trading at an extreme.

When I look for example into April LC - August LC I can see this spread has been trading most of the time above zero. It has been trading below zero only a few times in the last 20 years. We both probably agree when I say it is a "normal" market situation whenever this spread is trading at an positive number.

Backwardation, seasonality, correlation...for me it is only an additional filter and it gives me some edge. But at the end it is like Joe always says "trade what you see". Try to look at the whole picture.

All the best
Andy