What is the 'Spot Price'
A spot price is the current price in the marketplace at which a given asset such as a security, commodity or currency can be bought or sold for immediate delivery. While spot prices are specific to both time and place, in a global economy the spot price of most securities or commodities tends to be fairly uniform worldwide. In contrast to spot price, a security, commodity or currency's futures price is its expected value at a specified future time and place.
BREAKING DOWN 'Spot Price'In the financial markets, spot prices are most frequently referenced in relation to the price of commodity futures contracts, such as contracts for oil, wheat or gold. A futures contract price is commonly determined using the spot price of a commodity, expected changes in supply and demand, the risk-free rate of return for the holder of the commodity, and the costs of transportation or storage in relation to the maturity date of the contract. Futures contracts with longer times to maturity normally entail greater storage costs than contracts with nearby expiration dates. For example, on May 14, 2016, the spot price for wheat was $4.78 per bushel, the July 2016 futures price was $4.90 per bushel, and the December 2016 futures price was $5.22 per bushel.
Spot prices tend to be subject to extreme volatility. While the spot price of security, commodity or currency is important in terms of immediate buy-and-sell transactions, it perhaps has more importance in regard to the multitrillion-dollar derivatives markets. Options, futures contracts and other derivatives allow buyers and sellers of securities or commodities to lock in a specific price for a future time when they expect to make a transaction. Through derivatives, buyers and sellers can partially mitigate the risk posed by constantly fluctuating spot prices.
Futures contracts also provide an important means for producers of agricultural commodities to hedge the value of their crops against future price fluctuation.
The Relationship Between Spot Prices and Futures Prices
The difference between spot prices and futures contract prices is usually significant. The most common relationship between spot prices and futures prices, referred to as a normal market, is one where futures contract prices are increasingly higher over time as compared to the current spot price. The higher futures prices reflect carrying costs such as storage, the additional risk posed by the uncertainty of future supply and demand conditions in the marketplace, and the fact that prices for goods generally tend to increase over time.
In an inverted market, futures prices are decrease in comparison with the current spot price. Inverted markets are most frequently caused by extreme demand pressures in the current marketplace that enable sellers to command premium prices for immediate sale and delivery.