Before you get into trading in stocks, it is highly essential for you to know the important terms that are widely used in the stock market. ‘Spot price’ is one such term that’s predominantly used while trading. What is the spot price and what influences the spot price are some of the questions that we’ll be answering in this article. First, let’s start off with trying to understand the spot price meaning.
What is the spot price?
When you log into your trading portal and take a look at the stocks in your watchlist, the price that appears beside the stocks is what is known as the spot price.
In a slightly more technical sense, the present market price of a stock or any other asset for that matter is the spot price. Let’s assume that you wish to buy the stock of a company right this moment. To do so, you would have to pay the spot price for the stock that’s flashing right at the moment of placing the buy order. Here’s an example that might help you better understand the spot price meaning.
Assume that you want to buy the stock of HDFC Bank Limited. The current market price of the stock is at Rs. 1,200. This is what is known as the spot price. To buy one share of HDFC Bank Limited, you would have to pay Rs. 1,200. And since the spot price of a stock is constantly changing every second, by the time you place the order for buying one share of the company, the price would have undergone a change. In this case, you might have to use a ‘market order’ to buy the stock at the spot price as of the time of placing the order.
What’s the relationship between spot price and futures price?
Now that you know the spot price meaning, let’s delve a bit further and try to understand the relationship between spot price and futures price. What is the futures price, you ask? Here’s a brief explanation.
The futures price of an asset is the price that you’re required to pay now for a transaction that is slated to happen in a future date. For instance, let’s assume that you wish to buy a share of HDFC Bank Limited one month from now. The price that you’re required to pay now in order to be able to purchase a share of HDFC Bank Limited one month from now is Rs. 1,205. This is what is known as the futures price.
Okay, so now that you’re clear on what spot prices and futures prices are, let’s examine the relationship between these two.
– The spot priceof an asset is the base with which the futures price of that asset is determined. Ascertaining the futures price of any asset is not possible without the spot price of that asset. Additionally, the futures price of an asset may either be equal to, lower than, or higher than the spot price of the same asset.
– When the futures price is equal to the spot price, such a situation is usually labeled as convergence. This typically happens on the date of expiry of a futures contract.
– When the futures price is lower than the spot price, the situation is labeled as backwardation. This is quite rare and doesn’t happen all the time.
– When the futures price is higher than the spot price, which is quite normal and happens most of the time, the situation is labeled as contango.
– Irrespective of whether the futures price is in contango or backwardation with the spot price, as the expiry of the futures contract approaches, both the prices would automatically converge.
With the spot price, you’re required to pay the entire amount upfront for immediate delivery of shares. With the futures price, you’re only required to pay a portion of the amount upfront, known as the margin. You would have to pay the remaining amount once the contract expires. And upon the payment of the amount in its entirety, you will be allowed to take delivery of the shares that you bought. This is one of the main differences between the spot price and the futures price.