SPOT PRICE

Definition

The spot price is the current market price at which an asset, such as a commodity, security, or currency, can be bought or sold for immediate delivery. It reflects the price agreed upon for transactions that settle "on the spot," usually within two business days for most financial instruments, though some markets (like cash FX) settle the same day.

Spot prices serve as the benchmark for pricing derivatives such as futures, forwards, and options.

Origins

• "Spot" comes from the notion of settling a trade on the spot.

• The concept became formalized in the 19th century with the growth of commodity exchanges and money markets, where “spot” transactions were distinguished from forward-dated trades.

Usage

• Commodities – Oil, gold, wheat spot prices determine physical trade and derivative pricing.

• Forex – Spot rate is the exchange rate for immediate currency delivery.

• Equities – Spot price is simply the current share price in the open market.

• Cryptocurrency – Real-time value for immediate purchase or sale of digital assets.

• Precious Metals – Gold/silver spot prices form the basis for bullion transactions.
  
  

How Spot Price Works

The UIP condition says:

1. If a foreign country’s interest rate is higher than the domestic interest rate…

2. The foreign currency is expected to depreciate against the domestic currency…

3. So that expected returns (adjusted for FX changes) are equalized between the two countries.
   
   

Types of Spot Markets

• Over-the-Counter (OTC) – Direct transactions between parties.

• Exchange-Traded Spot Markets – Centralized exchanges (e.g., LME for metals).

• Decentralized Digital Spot Markets – For cryptocurrencies.
  
  

Key Takeaway

• Spot price = price for immediate delivery.

• Used as baseline for derivatives pricing.

• Highly sensitive to market supply/demand shifts.

• Varies by location and market (e.g., WTI crude oil spot price vs. Brent crude).

Context in Financial Modeling

• Commodity price forecasting – Spot prices serve as starting points for forward curves.

• FX hedging models – Spot rates anchor forward rate calculations.

• Equity valuation – Stock spot price is key for real-time valuation.

• Arbitrage analysis – Compares spot and forward/futures prices for mispricing opportunities.
  
  

Nuances & Complexities

• Risk Premium – Real markets demand extra returns for taking currency risk, so UIP often fails empirically.

• Short-term deviations – UIP tends to work better over the long term.

• Behavioral factors – Investor biases can cause persistent mispricing.

• Market frictions – Transaction costs, capital controls, and illiquidity distort UIP relationships.
  
  

Mathematical Formulas

In the absence of arbitrage, the theoretical relationship between the spot price ($S_0$) and futures price ($F_0$) is given by:

$$F_0 = S_0 \times e^{(r + c - y)T}$$

Where:

• $r$ = Risk-free interest rate

• $c$ = Storage/holding cost

• $y$ = Convenience yield

• $T$ = Time to maturity (in years)

Related Terms

• Interest Rate Parity (IRP)

• Covered Interest Rate Parity (CIP)

• Carry Trade

• Forward Premium Puzzle

• Exchange Rate Expectations

Real-World Applications

Example 1: FX Forward

An importer agrees to buy €1M in 90 days at $1.10/€, protecting against euro appreciation.

Example 2: Commodity Forward

A wheat producer locks in $6.50/bushel for a harvest due in six months, eliminating price uncertainty.

Example 3: NDF

A company operating in a restricted currency market (e.g., INR/USD) uses an NDF to hedge without physical currency delivery.

References & Sources

• Quickonomics: Uncovered Interest Parity