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Subject 5. Spot and Futures Pricing PDF Download
Commodities have two general pricing forms: spot prices in the physical markets and futures prices for later delivery. The spot price is the current price to deliver or purchase a physical commodity at a specific location. A futures price is an exchange-based price agreed on to deliver or receive a defined quantity and often quality of a commodity at a future date.

The difference between spot and futures prices is generally called the basis.

Contango is the situation where the price of a commodity for future delivery is higher than the actual spot price. It is a term that describes an upward sloping forward curve.

Backwardation is the opposite of contango. In this state, near prices become higher than far (i.e., future) prices because consumers prefer to have the commodity sooner rather than later.

A market that is steeply backwardated (a positive calendar spread) often indicates a perception of a current shortage in the underlying commodity. By the same token, a market that is deeply in contango (a negative calendar spread) may indicate a perception of a current supply surplus in the commodity.

The difference between gold and oil is the usage of each and their storage costs. Backwardation very seldom arises in money commodities like gold or silver. This is because it costs a large amount of money to store oil, whereas gold costs next to nothing to stash somewhere. Every barrel of oil that is extracted, on the other hand, is meant for consumption. The cost of storing oil on speculation or for arbitrage is just too huge to make it a profitable activity unless there were an absolutely huge positive premium between near and far month contracts.

Commodity contracts can be settled by either cash or physical delivery. Spot prices are highly localized and vary across regions based on quality/composition and local supply and demand factors. They are associated with physical delivery. Futures contracts are based on standardized specifications for composition and quality. Futures prices can be global for trading on exchanges and price discovery.

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