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Spot vs Futures in Commodities

Spot is the price for immediate delivery. Futures is the agreed price for delivery later. The relationship between them is the foundation of commodity trading.

Cost of carry

For a storable commodity, buying now and holding to a future date should cost the same as agreeing a future price today:

F=S e(r+c−y)TF = S\,e^{(r + c - y)T}

with SS spot, rr the interest rate, cc storage and insurance costs, yy the convenience yield, and TT the time to delivery.

The first three terms are straightforward: financing and storage make future delivery more expensive than spot.

Convenience yield

The fourth term is what makes commodities different from financial assets. Convenience yield is the benefit of holding the physical good rather than a promise of it.

A refinery with crude in its tanks can keep running through a supply disruption. A manufacturer with copper on site does not halt production waiting for delivery. That optionality is worth something, and it enters the formula as a negative carrying cost.

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