Spot Price vs Futures Price

Understanding the relationship between spot and futures prices is fundamental to commodity investing, currency trading, and fixed income markets. The two prices are linked by a cost-of-carry relationship: in theory, the futures price should equal the spot price plus the cost of carrying the asset — storage costs, financing costs, and insurance — minus any income or convenience yield generated by holding the physical asset.

For commodities held in inventory (storable commodities like oil, natural gas, gold, and agricultural products), when futures prices are above the spot price, the market is said to be in contango. This structure reflects normal cost-of-carry economics: buyers are willing to pay more for future delivery because it saves them current storage, financing, and insurance costs. Contango creates a headwind for long futures investors who must roll their positions: as each futures contract approaches expiration, they must sell it (near expiry, near the spot price) and buy the next contract (priced higher), generating a loss on each roll.

When futures prices are below the spot price, the market is in backwardation. Backwardation typically signals tight current supply relative to demand — holders of physical inventory place a high value on having the commodity now (convenience yield), which pushes spot prices above futures. Backwardation is rewarding for long futures investors because they sell expiring contracts at relatively high prices and buy cheaper next-month contracts. Many historical studies of commodity risk premiums focus on backwardated markets as the most attractive environment for long commodity exposure.

In currency markets, the relationship between spot and forward exchange rates is governed by covered interest rate parity. The forward rate differs from the spot rate by an amount that reflects the interest rate differential between the two currencies. If the US dollar interest rate is higher than the Euro interest rate, the dollar should depreciate in the forward market (dollar forward is weaker than spot) to prevent risk-free arbitrage. In equity index futures, the fair value relative to spot reflects the risk-free rate and the expected dividend yield on the index.

For financial instruments like equity index futures and Treasury note futures, the spot-futures relationship is generally kept tight by active arbitrage. In commodity markets, the relationship can deviate more significantly because physical arbitrage requires the ability to actually store and deliver the commodity, which is capacity-constrained and expensive — creating room for persistent pricing anomalies that pure financial arbitrage cannot fully close.