Backwardation Basic Points Backwardation can be defined as when the current price of an underlying security is higher than forward prices trading in the futures market. But it can also be used to define when the implied volatility (expected percentage move over a year with 68.3% confidence) is lower on the back months as opposed to the shorter-duration contracts. For example, if a security has a 30 DTE (days to expiration) monthly contract with 70% implied volatility (IV), a 60 DTE contract with 60% IV, and a 90 DTE contract with 50% IV, then it is in backwardation. Sometimes this pattern analysis of backwardation is applied merely to the first two months, but quite often it will analyze a term structure curve (IV over time) for about seven months out. The term structure is a 2D view of how IV changes over time, which visualizes how relatively expensive options are on those dates. Intermediate: Backwardation vs Contango Backwardation is the opposite of contango, which is when the front months in the term structure have a higher IV than the back months. Backwardation is also generally rarer than contango. Backwardation communicates fear in the market because it shows how the option market is pricing in larger moves in the immediate future—as opposed to the more natural contango case of IV and/or priced becoming slightly greater further out in time. With contango, the meaning is generally that the futures market is pricing in a near-term increase of the price. But in some cases, that increase in the forward (future) price is a premium for the futures contract in exchange for the convenience of using that leverage or not needing to hold a physical commodity sooner–or ever if merely speculating for profit. Advanced: How to Find Edge with Term Structure Strategically, traders like to take advantage of term structure edge with backwardation by writing options on the front months and buying them on the back months. This would be a reverse calendar spread (a horizontal options structure involving at least two different expirations). However, this perceived edge can be undermined by seasonal or transient conditions which rightfully justify those differences in prices from one month to the next. Related articles Barrier Option Beta-Weighted Backtesting Back Month vs Front Month Absorption and Exhaustion