Why do futures prices rise

There are many different futures markets: agricultural products, oil, precious metals and interest rates to name a few. At Avendra, we care primarily about corn, soybean, coffee, cattle, hog and cotton futures because they influence the prices our clients pay for their food and textiles.

Agricultural futures markets are fundamentally driven by supply and demand. The key supply factors for agricultural commodities tend to be the number of acres planted, the weather in the growing region, and the yield from the crop.

Demand for agricultural products tends to be relatively steady there are some exceptions, but they are more short term in nature , driven by population growth and evolving dietary preferences. Buyers and sellers use futures markets to mitigate risks. For example, a farmer growing soybeans can mitigate the risks of a disease that could harm his crop by locking in prices several months in advance of the crop being harvested.

Both sides benefit. Producers have a ready buyer and can proceed with their work, and get financing for their operations as needed. Wholesale buyers know what they'll be spending for supplies in the coming period, and can budget accordingly. But that "reasonable" price may change repeatedly between the time that it is set and the time that the commodity is actually ready to deliver. A storm or a pest may reduce the supply of a crop and drive prices up.

A recession may reduce consumer demand for precious metals and drive prices down. Futures traders try to make a profit off on the difference between the futures price that has been set and the value of the commodity at the time it is actually ready for delivery.

That value is the spot price. Suppose that the futures contract for corn is priced higher than the spot price as the contract's month of delivery approaches.

When this happens, traders see an arbitrage opportunity. That is, they will short futures contracts, buying the underlying asset, and then make the delivery. As arbitrageurs short futures contracts, futures prices drop because the supply of contracts available for trade increases.

The trader profits because the amount of money received by shorting the contracts exceeds the amount spent buying the underlying asset to cover the position. As for the pressure of supply and demand, the effect of arbitrageurs shorting futures contracts causes a drop in futures prices because it creates an increase in the supply of contracts available for trade.

Subsequently, buying the underlying asset causes an increase in the overall demand for the asset and the spot price of the underlying asset will increase as a result. As arbitragers continue to do this, the futures price and the spot price will slowly converge until they are equal, or close to equal. The same sort of effect occurs when spot prices are higher than futures, except that arbitrageurs would in that case short sell the underlying asset and long the futures contracts.

Trading Basic Education. Metals Trading. Your Privacy Rights. To change or withdraw your consent choices for Investopedia. I Accept Show Purposes. Your Money. Personal Finance. Your Practice. Popular Courses. Table of Contents Expand. Commodity Spot Price vs. Futures Price. Commodity Spot Price. Commodity Futures Price. Special Considerations: Basis. Futures Price: An Overview It may seem odd that something can have two prices at once. Key Takeaways The main differences between commodity spot prices and futures prices are the delivery dates.

The spot price of a commodity is the current cash cost of it for immediate purchase and delivery. The futures price locks in the cost of the commodity that will be delivered at some point other than the present—usually, some months hence.

The difference between the spot price and futures price in the market is called the basis. Broadly speaking, futures prices and spot prices are different numbers because the market is always forward-looking. Compare Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation.

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Related Articles. Forward Contract: What's the Difference? Commodities Who Sets the Price of Commodities? Commodities Commodities: The Portfolio Hedge. Partner Links. Related Terms Short the Basis Short the basis refers to the simultaneous buying of a futures contract and selling the underlying asset to hedge against future price appreciation. Forward Spread Definition Forward spread is the price difference between the spot price of a security and the forward price of the same security taken at a specified interval.

What Is Convergence in Investing? Convergence is the movement of the price of a futures contract toward the spot price of the underlying cash commodity as the delivery date approaches. What Is Forward Delivery? Forward delivery is the final stage in a forward contract when one party supplies the underlying asset and the other takes possession of the asset.