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Difference Between Spot and Futures Prices
Spot price is the current market price of particular commodity in the spot market, which is also called as cash market. That's the price which is prevailing 'on the spot' where one buys and sells goods. If you wanted to buy barrel of oil or 10 grams of gold today, you would pay the spot price.
The 'futures price' is the price of the same commodity at a future date. The price which you would pay today for the right to receive the commodity at some point of time in future, say after 3 months.
Hence, if the spot price for 10 grams of gold is worth Rs 22,000, the 1-month future price could be Rs 22100, while the 2-month future price could be Rs. 22200.
The difference between the spot price and the futures price is due to 'cost of carry'. Cost of carry is the cost attached with holding the physical commodity for a specified period of time such as cost of inventory, insurance, interest, etc.
Usually futures price is higher than the spot price, this is known as 'Contango'. And, a situation in which the futures price is lower than the spot price is said to be in 'Backwardation'. Example of backwardation can be seen in the case of agricultural commodities where after a good monsoon, you can expect the futures price of crop to be lower than that of spot price.
Futures and Futures Contract
Futures are the financial instruments that have physical underlying asset (commodity, currencies, equities, etc). A futures contract is a standardised contract between two parties to buy or sell an asset at a specified time in the future for a price agreed today.
For example, if a person wants to buy 10 grams of gold after three months. Spot price for the gold is say, Rs 22,000 for 10 grams and 3 month futures price is Rs 22,300 for 10 grams.
The investor would enter into a futures contract to buy gold through a member of NCDEX.
On the due date if the price in the spot market is Rs 23,000 for 10 grams, then s/he still will pay only Rs 22,200 because s/he had fixed the price of gold when they entered into a futures contract. Therefore, it can be stated that s/he has 'hedged' against the price rise risk.
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