Backwardation

[passcfaforsure]

Dear All:
What does it mean by this phrase in the answers below” For backwardation to occur, there must be a significant benefit to holding the asset, either monetary or non-monetary”
Thank you so much for your time.
Backwardation refers to a situation where:
A)
the futures price is above the spot price.
B)
long hedgers outnumber short hedgers.
C)
the futures price is below the spot price.
Your answer: C was correct!
Backwardation refers to a situation where the futures price is below the spot price. For backwardation to occur, there must be a significant benefit to holding the asset, either monetary or non-monetary.

 

[ajs57]

Consider the cost-of-carry model where futures price = [spot price X (1+risk free rate)] - future value of net costs.
In a situation where your net costs (ie, costs minus benefits) are negative, your benefits will outweigh your costs. This negative value in your cost-of-carry will cause your futures price to be lower than your spot price. As you are aware, FP < SP is the very definition of backwardation.
Hopefully, this helps…

 

[ajs57]

Consider the cost-of-carry model where futures price = [spot price X (1+risk free rate)] - future value of net costs.
In a situation where your net costs (ie, costs minus benefits) are negative, your benefits will outweigh your costs. This negative value in your cost-of-carry will cause your futures price to be lower than your spot price. As you are aware, FP < SP is the very definition of backwardation.
Hopefully, this helps…