What it means
At its core, a futures price is simply a prediction of what an asset will be worth later, plus the costs of carrying that asset until the delivery date. When two parties enter a futures contract, they agree on a fixed price today for a transaction that will happen next month or next year.
This removes uncertainty for both sides. For non-finance managers, understanding this concept is crucial for budgeting and risk management, especially if your business relies on raw materials, commodities, or foreign currencies.
In business, market prices fluctuate constantly due to supply and demand, weather, or economic shifts. If you run a bakery, flour prices might double by autumn.
By using futures contracts, you can secure a set futures price today, ensuring your flour costs remain predictable regardless of market chaos. This gives you stability when pricing your products and planning your annual budget.
Futures prices are determined through public exchanges where buyers and sellers constantly bid and offer based on their expectations of future supply and demand. If a drought ruins crops, the futures price for wheat will rise immediately.
While futures are heavily used by large commodity traders, smaller businesses often use them indirectly through suppliers who have locked in their own costs. For managers, tracking these prices provides valuable market intelligence.
Even if you never buy a futures contract directly, the futures price tells you what the wider market expects costs to do in the months ahead. This helps you decide whether to stockpile inventory now or wait for better conditions later on.
Imagine booking a holiday hotel room six months in advance for one hundred pounds a night. Even if local tourism booms and walk-in rates jump to two hundred pounds by the time you arrive, you still pay the agreed rate because you locked it in early.
In practice
Real-world examples
Example 1
A coffee shop owner locks in a futures price for coffee beans at $4 per kilo for delivery in six months. This protects her profit margins from expected market spikes. She can print her menu prices with confidence, knowing her main ingredient cost is fixed.
Example 2
A manufacturing SME uses metal futures to lock in steel prices for the next quarter. Customer quotes remain accurate and profitable despite rising market volatility. The firm's sales team can quote fixed prices without worrying that steel will rise before the order is made.
Example 3
A transport company buys fuel futures to lock in diesel costs for its delivery fleet. This prevents sudden spikes at the pump from destroying its monthly operating budget. The finance team compares the locked price with the pump price each month to see what the hedge is saving or costing.
Think of it
Imagine booking a holiday hotel room six months in advance for one hundred pounds a night. Even if local tourism booms and walk-in rates jump to two hundred pounds by the time you arrive, you still pay the agreed rate because you locked it in early.
Formula
Calculation
Futures Price = Spot Price + Carrying Costs (Storage + Insurance + Interest) - Expected Benefits (like dividends or yields).
Example: If wheat currently costs $200 per tonne (spot price), and it costs $10 to store and insure it for three months while earning $2 in interest benefits, the futures price will be 200 + 10 - 2 = $208 per tonne.
A second example shows how financing costs enter the price. Wheat has a spot price of $200 per tonne. Financing it for three months at an annual rate of 5% costs 200 x 5% x 0.25 = $2.50, and storage and insurance cost $4. The futures price is 200 + 2.50 + 4 = $206.50 per tonne.
A third example shows what a hedge can cost as well as save. A bakery locks in 100 tonnes at $208. If the spot price at delivery has fallen to $190, the bakery pays 208 - 190 = $18 per tonne more than the market, a difference of 100 x 18 = $1,800. In return it had a fixed, predictable cost for its budget, which is the real purpose of the contract.Case study
Seen in the real world
This is a fictional, illustrative scenario. Northfield Bakery, a mid-sized commercial bakery producing bread for regional supermarkets, faced severe profit squeezes due to wildly fluctuating wheat costs. The finance manager decided to use wheat futures to stabilise expenses. In January, she locked in a futures price of $220 per tonne for 500 tonnes of wheat, scheduled for delivery across the autumn months.
By September, poor global harvests drove the spot market price of wheat up to $280 per tonne. Because Northfield Bakery had secured the futures price early, they avoided the massive $60 per tonne surcharge that competitors had to pay. This disciplined hedging strategy saved the company $30,000 in raw material costs during the peak autumn production period. Consequently, Northfield maintained its profit margins and kept its bread prices steady for supermarket clients, gaining valuable market share from rivals who were forced to raise their prices rapidly.
Watch out
Common mistakes
- Assuming the futures price is a guaranteed prediction of the future spot price, when it is actually just a calculation based on current costs and expectations.
- Treating a futures contract like an optional insurance policy rather than a legally binding obligation to buy or sell.
- Failing to account for carrying costs when comparing current spot prices with future delivery prices.
Questions
People also ask
Who sets the futures price?
The futures price is set by the market through the continuous interaction of buyers and sellers trading on public financial exchanges.
Do I have to take physical delivery of the asset?
No. Most business managers and investors settle futures contracts in cash or close out their positions before the delivery date arrives.
Why is the futures price different from the current spot price?
The difference accounts for the cost of carrying the asset over time, such as storage, insurance, and financing expenses, plus market expectations.