Here is a quick explanation of how Contango works. For every seller in the market there is a buyer and in the Contango strategy we are the seller. The product we are selling is insurance and the buyers are fearful investors.
The insurance product is based on the volatility of the S&P 500. We earn a premium until the market takes a dive (like it did in Q4 of 2018).
The following chart helps to visualize how it works. The insurance contracts for our volatility product, the VIX are currently in Contango. This means the front month contract (July) is $15.70 and the second month contract (August) is $16.62.
We are currently selling the August contract at $16.62 and buying the July contract for $15.70 earning a $0.92 premium in the process. The contracts are for the same product just at a different period in time. This concept of the future being more expensive than the present is the definition of Contango.
The premium seen above (Contango) has historically been in our favor about 80% of the time. The chart below displays this in more detail.
Anytime the blue line is above the red line the investment is earning a premium. The premium has resulted in an unadjusted compounded return of about 40% per year and is the basis of our Contango strategy.