Definition of Spot Price
A spot price is the current market rate at which a specific asset—such as a product, security or currency — can be purchased/sold for immediate delivery. While spot prices are time-and-place-specific, when adjusting for exchange rates in a global economy, the spot price of most securities or commodities appears to be fairly uniform globally. Unlike the spot price, a futures price is a negotiated price for the asset's future delivery.
Let's Understand What a Spot Price is in Detail
Spot prices are most often cited in relation to commodity futures contracts, such as wheat, gold, or oil contracts. That is because stocks are always trading on the spot. At the quoted price, you buy or sell a stock, then exchange the stock for cash.
A futures contract price is usually calculated using a commodity's spot price, anticipated changes in demand and supply, the risk-free rate of return for the commodity holder, and the shipping or storage costs relative to the contract's maturity date. Future contracts with longer times to maturity normally involve a higher cost of storage than contracts with close expiry dates.
A futures contract will also render an important way for farm product producers to hedge the value of their crops against price fluctuations.
What is the Relationship Between a Spot Price and a Future Price?
The difference between a spot price and a futures contract price can be crucial. A future price can either be in contango or in backwardation. Contango is when a future price declines to arrive at a lower spot price. Backwardation is when a future price increase to match the current spot price.
Backwardation tends to be in favour of net long positions, as future prices rise to meet the spot price while the contract reaches expiry. Contango supports short positions since the future price loses value as the contract reaches expiry, and the lower spot price converges.
