What it means
Every traded commodity or currency has a price for settlement today or within a day or two. That is the spot price, and it moves constantly as buyers and sellers react to news, supply and demand.
It is quoted by exchanges, dealers and data providers, and it is the reference point for most other pricing. Spot prices differ from futures prices because time has a cost.
A buyer who agrees today to take delivery in six months must allow for storage, insurance and the interest on money tied up, and for what the market expects to happen. The gap between the spot price and the futures price is called the basis.
When futures prices are higher than spot, the market is said to be in contango, and when they are lower it is in backwardation. These patterns tell finance teams something about expectations and supply tightness.
A steep backwardation, for example, often signals a shortage of the physical product right now. Companies use the spot price in several ways.
A manufacturer buying metal may pay the spot price plus a premium, an exporter converts foreign income at the spot exchange rate, and a treasurer values holdings at the spot price on the reporting date. Because the price is so volatile, many firms fix their costs in advance through contracts or hedges.
The quoted spot price is rarely the full cost of getting the goods. Delivery charges, quality differences, taxes and dealer margins all add to what a buyer actually pays.
For physical goods, the contract should state exactly which grade, location and delivery terms the price refers to. Spot prices can also be distorted in thin markets or at times of stress, when few trades take place.
In those moments the quoted price may not be one at which you can actually deal. It is wise to ask for firm quotes before relying on a screen price.
In practice
Real-world examples
Example 1
A jewellery maker needs 50 ounces of gold for an order. It buys at the spot price quoted that morning, plus a dealer premium. The finance team records the cost and compares it with the price in the customer's quote.
Example 2
An exporter receives a payment in euros and converts it to dollars at the spot exchange rate on the day. A fall in the euro over the previous week reduces the dollar amount. The treasurer starts to consider forward contracts for the next shipment.
Example 3
A food manufacturer buys wheat on the spot market because a harvest has failed and its usual supplier cannot deliver. The price is much higher than its budget assumed. The cost team updates its margin forecast for the quarter.
Think of it
The spot price is like buying a hot dog from a street vendor. You pay the price on the sign and eat it right now. A future price is like ordering a custom cake to be delivered and paid for on your birthday next month.
Formula
Calculation
Spot purchase cost = spot price x quantity; basis = spot price - futures price
Suppose a refinery buys 10,000 barrels of crude oil at a spot price of $80 per barrel. The cost is 10,000 x 80 = $800,000. The six-month futures price is $84, so the basis is 80 - 84 = -$4, a negative basis that shows the market is in contango. Locking in the futures price for the same quantity would have cost 10,000 x 84 = $840,000, which is 840,000 - 800,000 = $40,000 more than buying at spot.Case study
Seen in the real world
Copperfield Cables is an illustrative, fictional manufacturer that bought copper at the spot price on the first day of each month. When copper prices jumped 15% in a quarter, its margins fell sharply because its customer contracts were at fixed prices.
The finance director reviewed the exposure. Copper cost about $1,000,000 a month, so a 15% rise added 1,000,000 x 0.15 = $150,000 a month to costs.
She introduced a policy of buying half of the expected needs in advance through forward contracts and the rest at spot. The illustrative lesson is that relying on the spot price alone leaves a business exposed to sudden swings, and a mix of fixed and spot purchases steadies the cost.
Watch out
Common mistakes
- Assuming the quoted spot price is the total cost of buying the goods, when premiums, delivery and taxes are extra.
- Using the spot price to forecast what the price will be in the future.
- Ignoring currency effects when buying commodities that are priced in another currency.
Questions
People also ask
What is the difference between spot and futures prices?
The spot price is for immediate delivery, while the futures price is agreed now for delivery on a set future date.
Does spot mean the trade settles instantly?
Usually it settles within a day or two, depending on the market, so check the settlement terms.
Why do spot prices move so much?
They respond quickly to changes in supply, demand, news and sentiment, and any single event can cause a large move.