Spot vs Futures

The spot price is the price for buying or selling an asset for immediate delivery. A futures price is the price agreed today for delivery at a future date. The two are linked: arbitrage keeps futures prices close to what it would cost to buy the asset today and hold it until the futures date. That link, known as the cost of carry, explains why futures sometimes trade above spot, sometimes below, and why they converge as expiry approaches.

The cost of carry model#

futures price = spot price × e^((r + u - y) × T)

• r: financing (interest) rate
• u: storage and insurance costs, as a rate
• y: income from holding the asset (dividends, coupons, lease rates) plus any convenience yield
• T: time to expiry in years

In simple terms: futures price ≈ spot + cost of financing + cost of storage minus income from holding.

Applying it to different assets#

Convenience yield#

For physical commodities, holding the actual stock has benefits that futures do not provide: a refinery with crude in its tanks can keep running during a supply disruption. This benefit is the convenience yield. When inventories are low and supplies tight, convenience yield rises, and futures can trade well below spot, which is called backwardation. See Backwardation and Storage and Inventories.

Basis#

The difference between spot and futures prices is called the basis:

basis = spot price - futures price

Hedgers watch basis closely because a hedge is only as good as the relationship between the futures and the actual price they care about. See Basis and Basis Trading.

Convergence at expiry#

As expiry approaches, T shrinks, carry costs shrink, and the futures price converges towards spot. At expiry, cash settled futures settle to the spot reference, and physically settled futures converge because traders can deliver or take delivery. If they did not converge, arbitrage would be easy.

Why spot and futures can diverge#

• Storage limits: when storage is full, futures can collapse below spot, as in April 2020 when WTI crude futures briefly traded negative. See Crude Oil.
• Shorting constraints in the underlying.
• Funding stress: when financing is scarce, arbitrage gaps widen.
• Crypto leverage demand can push futures far above spot in bull markets.

Frequently asked questions#

What is the difference between spot and futures prices?#

Spot is the price for immediate delivery; a futures price is the agreed price for delivery on a future date, adjusted for the costs and benefits of holding the asset until then.

Why are futures prices higher than spot?#

Usually because of financing and storage costs. Futures can be lower when the asset pays income or has a high convenience yield, as with tight commodity supplies.

Do futures prices converge to spot?#

Yes. As expiry approaches, carrying costs shrink and arbitrage forces the futures price towards the spot price.

Next, learn what it means when futures trade above spot in Contango.