Why There Is a Difference Between Spot Price and Future Price

The spot price and future price of an asset can differ due to several factors, including the cost of carry, supply and demand dynamics, and market expectations. Understanding these differences is crucial for traders and investors who engage in buying and selling commodities, stocks, or financial instruments with future delivery dates.

Spot Price refers to the current market price at which an asset can be bought or sold for immediate delivery. This is the price you see quoted on the stock exchange or financial market at any given moment. It's a snapshot of the current market conditions and reflects the immediate supply and demand for the asset.

Future Price is the agreed-upon price for an asset that will be delivered at a specified future date. Futures contracts are standardized agreements traded on exchanges that obligate the buyer to purchase, and the seller to sell, an asset at a future date for a predetermined price. The future price reflects market expectations of the asset’s price at the contract's expiration.

Cost of Carry: This is a significant factor in the difference between spot and future prices. The cost of carry includes expenses such as storage costs, insurance, and interest on the funds used to purchase the asset. For commodities, this can mean physical storage and handling fees. For financial instruments, it could involve the opportunity cost of tying up capital. The future price often includes these costs, making it higher than the spot price.

Supply and Demand: Market conditions play a crucial role. If there is a high demand for an asset but limited supply, the spot price may rise significantly. Conversely, if future demand is expected to increase or if there are anticipated changes in supply, the future price might be higher or lower than the spot price, depending on the expected trend.

Market Expectations: Futures prices also reflect the market’s expectations of future events. If investors expect the price of an asset to rise, the future price might be higher than the spot price. Conversely, if a price decrease is anticipated, the future price might be lower. This expectation can be influenced by economic indicators, geopolitical events, or other market factors.

Arbitrage Opportunities: Traders often look for arbitrage opportunities, which involve buying an asset at the spot price and selling it at the future price (or vice versa) to profit from the price discrepancy. These opportunities can exist due to temporary imbalances in the market, and they help to align spot and future prices over time as traders act on them.

Seasonality: Some commodities, such as agricultural products, experience seasonal price fluctuations. For example, the price of wheat may be lower at harvest time due to abundant supply but higher later in the year when supply is reduced. Future prices can reflect these seasonal patterns, leading to differences between spot and future prices.

Inflation and Interest Rates: Economic conditions such as inflation and interest rates can also impact the difference between spot and future prices. Higher interest rates generally increase the cost of carry, which can drive future prices up. Inflation expectations can influence future prices as well, especially for long-term contracts.

Supply Chain Disruptions: Events that disrupt supply chains, such as natural disasters, strikes, or geopolitical tensions, can impact both spot and future prices. However, the effects on future prices might be more pronounced as markets adjust their expectations for the future availability and cost of the asset.

Example Analysis:

To illustrate, let's consider the crude oil market. Suppose the current spot price of crude oil is $70 per barrel. If traders expect an increase in global demand or a reduction in supply over the next six months, the future price for delivery in six months might be set at $75 per barrel. This $5 difference reflects the anticipated increase in value due to expected changes in supply and demand, as well as the cost of carry.

Table: Spot vs. Future Prices of Crude Oil

Date	Spot Price (USD)	Future Price (USD)	Difference (USD)
August 2024	70	75	5
September 2024	72	78	6
October 2024	71	76	5

Summary: The difference between spot and future prices arises from various factors, including the cost of carry, market expectations, and economic conditions. By understanding these factors, traders and investors can make informed decisions and potentially capitalize on price discrepancies.