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Definition: Inverted Market
Inverted Market is a situation in the market when the short term or spot prices of the futures/options exceeds the long term price of the futures/options. Generally due to the carrying cost (interest cost-yield) of long term futures, the price premium is higher in long term futures. While in an inverted markets the short term future price sell at premium higher than long term futures.
Now Inverted markets conditions may develop due to the short supply in the markets. Due to the shortage, the demand becomes high thus driving up the prices. Inverted Markets are also known as backwardation markets. If spot price, price after one month and price after 2 months is compared, in normal markets the price after 2months is higher than 1 month which is higher than spot price. But in case of inverted markets, the prices show the opposite behaviour, spot price being the highest and so on. The starting of this behaviour is known as Contango which then becomes backwardation or inverted market. There are many sectors in which inverted market conditions are quiet usual due to the inherent nature of the sectors like energy or petroleum.
A typical overview of the normal and inverted markets can be shown as below.
For Example: Suppose there is a lack of rainfall this year due to which there occurs a shortage of wheat supply in the markets. Now due to this short supply, the spot prices of the wheat future will rise and Wheat futures will sell at premium now as compared to the long term wheat futures prices.