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Imagine you are a business that knows it needs to purchase a commodity, like oil, in the future. You anticipate that the price of oil may rise from now until you need to make that purchase. To protect yourself from this potential price increase, you can use a strategy called a 'long hedge'.

In a long hedge, you enter into a futures contract, which is essentially an agreement to buy the commodity at a predetermined price at a future date. This allows you to lock in the price today, even though you don't need the commodity yet. By locking in the futures price, you avoid the risk of having to pay a higher spot price when the time comes for you to make the purchase.

This hedging strategy is particularly beneficial in situations where futures prices are lower than expected spot prices in the future. This way, you can be sure of the cost you'll pay, providing both certainty and potential savings.

Backwardation is a market condition where the futures prices are lower than the current spot prices. This occurs for various reasons, one being investor expectations that the price of the asset will decrease in the future.

One reason investors might expect future prices to decline is due to temporary factors that are causing a hike in spot prices, like supply disruptions. Once these factors resolve, prices generally fall.

In backwardation, long hedges become appealing because you can lock in low futures prices, potentially benefiting from the future drop. Essentially, you may be able to secure a buying price that is more affordable than opting to purchase at the spot price today.

The cost of carry refers to the costs associated with holding or storing a physical commodity. These costs include storage fees, insurance, and financing charges. The cost of carry influences the relationship between futures and spot prices.

When the cost of carrying an asset is high, futures prices often exceed the spot prices, a situation known as contango. Conversely, a negative or low cost of carry can result in backwardation, where futures prices are below spot prices.

Understanding the cost of carry is important for investors making decisions about entering futures contracts. In backwardated markets, where futures prices are lower than spot prices, the cost of carry might be lower due to lower inventory or storage costs, making long hedging strategies attractive.