Alternate name: cash price
You’ll likely hear about spot prices if you’re trading commodities, which are physical goods like gold and silver, oil, wheat, or lumber. Commodities trade on both the spot market, which is the market for immediate delivery, and the futures market, which is the market for future delivery. In commodity trading, the seller makes a legal commitment to deliver an agreed-upon quantity of the commodity on a certain date at a specified price. The spot price is (the immediate price), it is a key factor in determining how futures contracts are priced. For example, say a barrel of crude oil is trading at $68 one day. However, its futures contract with a settlement date of one year later was priced at $64 per barrel, indicating that the market expected oil prices to drop. The spot price of crude oil that day would be $68, and the contract price would be $64, which would be based in part on the spot price. In another example, consider that gold is trading for $1,780 per ounce, but its futures contract for one year later was $1,786. In this case, investors expect gold prices to rise. The spot price would be $1,780 and the futures contract price would be $1,786. You probably won’t hear the term “spot price” very often when you invest in stocks because stocks always trade at spot price. You buy a stock for the quoted price, and the transaction occurs immediately. So there is no need to make a distinction from another type of price.
How Do Spot Prices Work?
Commodity traders use futures contracts for two primary purposes: as a hedge against increases or decreases in the spot price, or to speculate that the spot price of a commodity will increase or decrease. A wheat farmer who’s worried that the spot price will be lower by the time she harvests her crop and brings it to market may sell a futures contract as a hedging strategy. A company that needs to secure the farmer’s wheat may buy the forward contract as a hedge in case the spot price of wheat increases. A third-party speculator aiming for profits could also buy or sell the forward contract based on whether they predict the spot price of wheat will rise or fall.
What Spot Price Means for Investors
If the spot price is lower than the futures price for a commodity—meaning the price of the commodity is expected to rise—the market is said to be in “contango.” When the spot price is higher than the futures price and the commodity’s price is expected to drop, the market is in “backwardation.” Spot prices and futures prices tend to converge as the contract gets closer to expiration. Predicting changes in spot prices can be tricky for investors. Unpredictable factors like weather, political instability, and labor strikes are among the many factors that can affect commodity prices. For individual investors who want to diversify with commodities, investing in an index fund that tracks a major commodity index may be a less risky option than investing directly.
