Derivatives Glossary: Premium, Discount, Contango, Basis

Futures and perp markets trade at prices that diverge from spot. The vocabulary below describes those divergences and what they signal.

Premium (in futures)

Futures price > spot price. Common in physically-delivered commodities with storage costs (oil, gold) and in bull markets for financial futures. A 3-month WTI contract at $80 vs spot $78 = $2 premium.

Premium reflects cost of carry: storage + financing − income. For non-yielding assets like gold, premium ≈ financing cost minus convenience yield.

Discount

Futures price < spot price. Indicates immediate demand for physical (backwardation) or expected price decline. Brent trading at a $1.50 discount to spot means the market pays you to hold the physical and sell forward.

In crypto perps, sustained discount (negative funding) signals bearish positioning — shorts pay longs, and the market expects lower prices.

Contango

A futures curve where each successive expiry is priced higher: front month < next month < next. Typical shape for storable commodities in equilibrium. Contango costs roll yield: a long-only futures position must sell the expiring cheap contract and buy the next dearer one, paying the spread each roll.

Annualized roll cost in WTI in deep contango: 8–15%. That drag is why USO underperforms spot oil in trending contango markets. Long-only commodity ETFs lose 1–5%/year to contango in normal conditions.

Backwardation

The opposite curve shape: front month > next month > next. Signals tight immediate supply. Long-only futures in backwardation earn positive roll yield — selling the expiring contract at a premium and rolling into the cheaper next.

Energy stocks in backwardation (2022 oil, 2023 natural gas episodes) typically outperform spot because E&P cash flows accelerate. Annualized roll yield in crude during backwardation: 10–20%.

Basis

The difference between spot and futures (or between two related contracts). Basis = spot − futures (some markets use futures − spot; confirm convention per venue).

• Positive basis (spot > futures): physical is scarce; bullish immediate demand.
• Negative basis (spot < futures): physical in surplus or financing costs dominate.

Basis trading: buy spot, sell futures (or vice versa), collect convergence at expiry. Annualized basis arb in crypto (cash-and-carry) returns 8–15% in calm markets, 25–40% during bull euphoria when perp funding runs hot.

Practical use

• Trade structure, not just direction: long futures in backwardation has tailwind; long futures in deep contango has headwind even if price rises.
• Curve shape predicts inventory: contango = surplus, backwardation = shortage. Confirm with EIA/DOE inventory data.
• Basis blowouts are signals: a sudden widening of basis often precedes a volatility event; flatten positions before resolution.