What it is:
How it works/Example:
On November 29, 2010, the spot price of gold was $1,367.40 per ounce on the New York Commodities Exchange (COMEX). That was the price at which one ounce of gold could be purchased at that particular moment in time. The spot price for a bushel of wheat was about $648 on the same day.
On November 29, 2010, the futures price for an ounce of gold to be delivered in December 2011 was $1,373.20. The futures price for December 2011 delivery of a bushel of wheat was about $764.
Large differences between the spot price and the futures price can exist because the market is always trying to look ahead to predict what prices will be. Futures prices can be either higher or lower than spot prices, depending on the outlook for supply and demand of the asset in the future.
Why it matters:
The spot price is important in and of itself because it is the price at which buyers and sellers agree to value an asset. But spot price becomes an even more important concept when it's viewed through the eyes of the $3 trillion derivatives market.
Spot prices are continually changing -- they fluctuate according to varying supply and demand. To mitigate the risk of continuously changing prices, investors created derivatives. Derivatives such as forwards, futures and options allow buyers and sellers to "lock in" the price at which they buy or sell an asset in the future. Locking in prices with derivatives is one of the most common ways investors reduce risk.
If you're interested in trading futures contracts, find out which brokers have the right tools by reading Essential Trade Tools for the Advanced Investor and The Ultimate Guide to Profiting from the Commodity Super Cycle.