The Spot Price: The Price for Immediate Delivery

The spot price is what one unit of the reference asset costs to buy or sell for delivery now rather than on some later date. On these invented figures it is Rs 2,000.00/-. Every price agreed today for a later date in this subject is built from it by adding what it costs to hold the reference asset until then, so the spot price is an input and never a forecast.

Rs 2,000.00/- has already appeared twice. The business there was with the obligation rather than with the number underneath it, so the treatment of the two contracts put Rs 2,000.00/- down, used it to build a price of Rs 2,130.00/- and moved on. The number underneath deserves a stop of its own. The spot price is the smallest idea in the whole sequence and the one every later idea leans on, and something that small carrying that much weight is worth ten minutes of attention rather than ten seconds.

The reason it repays that attention is simple. A price on its own is incomplete information. Somebody who says the reference asset is Rs 2,000.00/- has not said enough to act on. The listener does not yet know when the transaction being described takes place. The same reference asset carries one price for a transaction that happens now and a different price for a transaction that happens a year from now, and the entire difference between those two figures is the cost of bridging the time between them. A price is only meaningful once the date of the transaction it belongs to is known, and the spot price is the one whose date is now.

Everything worked below runs on a single invented reference asset. Its price for delivery now is Rs 2,000.00/-. Borrowing the money to buy and keep it runs at 6.50 per cent a year. And across the whole stretch it is held, nothing at all comes back out of it. No payout of any kind comes out of the reference asset, and that condition decides the direction of every figure that follows.

What exactly is the spot price?

The spot price is the price at which one unit of the reference asset can be bought or sold for delivery now. Nothing else belongs in the definition, and the flatness of it is deliberate. A spot price is not a summary of what people think of the reference asset. A spot price is not an estimate. A spot price is a number attached to a transaction with a date on it, and that date is today.

The spot price is a price, and saying which of four kinds of figure it is matters, because a figure in this subject is one of four things and mixing them up is the most common error a reader arrives with. A price is the figure a transaction is struck or quoted at. A premiumThe amount paid up front to acquire a position in certain instruments. Neither side of a forward or a future pays one. is what somebody hands over to acquire a position, and there is not a single premium anywhere in this sequence because neither of the contracts taught here is bought for one. A payoffWhat a position produces at the moment it settles, worked before subtracting anything paid to enter it. is what a position produces on the day it settles. A profit is what remains of that payoff once the cost of getting into the position has been removed from it. Rs 2,000.00/- is the first of those four and none of the other three, and each new figure below is named as one of the four as it appears.

The everyday version costs nothing to understand. A shopper reaches the vegetable market at seven in the morning and the price on the board is Rs 40.00/- a kilogram. The money changes hands, the kilogram goes into the bag, the shopper walks home. The Rs 40.00/- on the board is a spot price. Nobody at that stall is saying what vegetables will cost in October, nobody is offering a view, and a vendor asked whether Rs 40.00/- means the price is going up would look at the questioner strangely. The board price is what a transaction costs this morning. The reference asset works exactly the same way, only with more zeros and a settlement process that takes a couple of days instead of a couple of seconds.

What does the word immediate actually mean here?

Nothing in a market settles instantly, and a reader who takes the word immediate literally will be confused by the first real arrangement they meet. So it is worth saying plainly what the word covers. A spot transaction is one that settles inside the short window the market's own arrangements allow for a transaction done now, as against one deliberately dated to a stated later day. The money moves and the referenced thing moves within that window, whatever the window happens to be.

The length of that window is not a matter of arithmetic. How long that window is, for any given thing being transacted, is set by the Securities and Exchange Board of India (SEBI) at sebi.gov.in, it is not the same for everything transacted, and it moves. The timetable itself is kept by that authority.

The difference at stake is between being out of date and being wrong. A printed settlement window would not merely go stale on the day the requirement changed. A stale window would be flatly incorrect from that morning onwards and would still read as authoritative to somebody who had no reason to doubt it. A named authority with an empty value beside it cannot go wrong in that way. The name points to the place where the answer actually lives, and the answer has never lived anywhere else.

The vegetable stall shows the shape of it. The money goes across, the kilogram comes back, and nobody calls that a later transaction, even though maybe forty seconds passed between the money leaving one hand and the bag reaching the other. Nobody thinks those forty seconds turned a purchase now into a purchase later. The short window in a market does exactly the same work: it is the plumbing of a transaction that has already been agreed to happen now, and it is not the same thing as an arrangement whose whole point is that it happens on a stated day some months out.

Why does every other price in this sequence start here?

The answer to that question is one line. A price agreed today for a transaction on a later date is the spot price plus what it costs to hold the reference asset until that date. Not a related figure, not a figure that usually tracks it, not a figure produced somewhere else and happening to sit nearby. The later price is built out of the spot price, by arithmetic, in plain sight, and no second market decides it independently.

Readers arriving at this subject often go looking for that second market. Looking for one feels reasonable. Two prices are showing for the same reference asset, so surely two different sets of people are producing them, and surely the second set knows something the first does not. There is no such second set. The later price is what the first price becomes once the cost of getting from today to that date is added, and if it were anything else, somebody could buy at one price, sell at the other and pocket the difference without ever taking a chance on anything.

The consequence follows immediately. Every later price in this sequence is built on top of the spot price, so when the spot price moves, all of them move with it. A reader who has not taken that on board will spend the rest of this sequence looking for an explanation of the later price that stands on its own. No such explanation exists.

How far above the spot price does the later price sit?

Work it rather than reading it. Buying one unit of the reference asset today costs Rs 2,000.00/-, and holding it for a year means having Rs 2,000.00/- tied up for a year at a financing rateThe yearly cost of the borrowed money used to buy and hold something. A rate without a period is not a number, so the period is stated every time. of 6.50 per cent a year. Multiply: Rs 2,000.00/- times 0.065 gives Rs 130.00/-. The Rs 130.00/- is the carry, the cost of getting one unit of the reference asset from today to a date one year out. Add it: Rs 2,000.00/- plus Rs 130.00/- gives Rs 2,130.00/-.

Look at what is and is not in that expression. There is a price today, a rate and a length of time. There is no term for what anybody expects, no term for how likely anything is, and no term for how anybody feels about the reference asset. The whole of the gap between Rs 2,000.00/- and Rs 2,130.00/- is a financing cost, and a financing cost is not an opinion.

Now the condition that decides the direction, stated in the block where it does the work. The reference asset in this record pays out nothing at all while it is held. Nothing comes in during the year to offset the Rs 130.00/- of financing. The later price therefore sits above the spot price here, and on these figures it can never sit below it. Hold the money's cost against zero income and the answer only goes one way.

Suppose a referenced thing did pay something while it was held. The holder would then be receiving something during the year that partly offsets the borrowing cost, so the payout would be subtracted from the carry. A large enough payout would take the carry negative and put the later price below today's price. No such payout exists on these figures, so that case cannot be worked here. A payout of any size would change every number in this sequence.

Does the gap grow in rupees or in proportion?

Readers reliably get the next part wrong, and getting it wrong quietly turns a cost into a signal further on.

The gap is 6.50 per cent of whatever the spot price happens to be. The gap is not a fixed Rs 130.00/-. Rs 130.00/- is what 6.50 per cent of Rs 2,000.00/- comes to, and it is specific to that starting price. Change the starting price and the gap changes with it. Financing a bigger amount costs more, and financing a smaller amount costs less.

Do not take that on trust. Work it twice more, each time from its own spot price rather than by scaling the first answer.

Start at a spot price of Rs 1,600.00/-. Multiply: Rs 1,600.00/- times 0.065 gives Rs 104.00/-. Add: Rs 1,600.00/- plus Rs 104.00/- gives Rs 1,704.00/-. Now start at a spot price of Rs 2,400.00/-. Multiply: Rs 2,400.00/- times 0.065 gives Rs 156.00/-. Add: Rs 2,400.00/- plus Rs 156.00/- gives Rs 2,556.00/-.

Read the last column and then the last row. The rupee gap moves from Rs 104.00/- to Rs 156.00/-, a widening of Rs 52.00/- across a spot range of Rs 800.00/-. The proportion does not move at all: it is 6.50 per cent at every one of the three levels. The same rate does both jobs, so the widening of Rs 52.00/- against the spot range of Rs 800.00/- coming to 6.50 per cent is forced arithmetic rather than a second confirmation. One fact has been stated twice, not two facts agreeing.

A change in the financing rate feeds through this gap in a live control where the later price is taken apart, and the proportionality itself gets one where the two prices are set against each other.

What is the spot price not?

Three figures get mistaken for the spot price, and the distinctions are worth stating one at a time rather than as a list.

The spot price is not what the reference asset is worth. Worth is a judgement somebody makes, arrived at by whatever reasoning they favour, and two careful people can reach two different answers from the same information without either being careless. A price is not like that. A price is the figure a transaction is done at, and there is only one of it at a time. Somebody may believe the reference asset is worth far more than Rs 2,000.00/- or far less. Neither belief changes what the transaction costs this morning.

The household version. A flat in the neighbourhood sells for Rs 62,00,000/-. A neighbour is sure it was worth Rs 70,00,000/-. The buyer thinks he overpaid. The price of that transaction was Rs 62,00,000/-, flatly and without argument, and three people holding three different views about its worth changed nothing about the figure on the paper.

The spot price is not the price at which a transaction of any size can be done. A quote sits against some quantity, and asking for very much more than that quantity is a different question with a different answer. How prices are formed, who stands ready to transact at them and what it costs to do a large one are covered in the markets material. Rs 2,000.00/- is what a single unit costs, and it is taken no further than that.

And the spot price is not the price agreed today for a later date. Readers meeting the two side by side get into the most trouble right there. Rs 2,000.00/- and Rs 2,130.00/- are two different numbers for two different transactions, and the second was built out of the first by the arithmetic above. The two figures are related the way a bill and the same bill with a year of interest on it are related. Nobody thinks those two are the same figure, and nobody should think these two are either.

Which words go with which figures?

The labelling rule was set out at the start, and the table below carries every figure that has appeared, labelled. The same four words come back throughout, so one reading of the table makes the rest of the sequence easier.

Two things follow from that table and both matter later. A cost is not a payoff, and a payoff is not a profit, and each one is named as it appears. And the empty bottom row does work of its own. Readers who have met instruments bought for a premium arrive expecting one here, and looking for it is a good way to misread everything that follows.

How does somebody actually use this in the room?

The abstraction has to touch something, so here is where the spot price does real work for four different readers.

1. A treasurer at a business that will need the reference asset later starts here because it is the only figure in the conversation that is not a construction. Somebody offers to sell for delivery in a year at a stated price. The treasurer takes today's price, works the carry on it and sees what the offered price implies. If the offer sits well above Rs 2,130.00/- on these figures, the extra is not a mystery to be interpreted; it is something to ask about, item by item, before signing anything.
2. A lender deciding what to advance against a holding uses the spot price as the base, because that is what the holding could be transacted at now rather than what somebody argues it is worth. Everything the lender then does to that base, and how far below it the advance sits, is a separate subject worked elsewhere. What matters here is that the starting figure is a price rather than a judgement, which is exactly why it can be checked.
3. An analyst reading a gap between two prices asks first whether the gap is explained by carry. Take the spot price, multiply by the rate for the period, and see how much of the gap that accounts for. When it accounts for essentially all of it, there is nothing to interpret and no story to write. That is a genuinely useful finding, and it saves an afternoon.
4. A household saving for a purchase it will make later meets the same structure without any of the vocabulary. Buying the thing now costs today's price but ties up the money. Buying it later at a price agreed today costs more, and the extra is the cost of not having tied the money up. It is the same trade in both cases, and neither version requires an opinion about anything.

All four of those readers start from the spot price because it is the checkable figure, and everything else in the conversation is built on it. Precision about the base figure is therefore practical rather than pedantic. A reader who cannot say cleanly what the base figure means cannot audit anything constructed above it.

One arithmetic note belongs with the treasurer, and it is the only place collateral comes up at all. A cleared position on one unit of the reference asset stands on Rs 2,000.00/- of exposure, and on these figures the initial marginCollateral lodged with the party standing in the middle before a position may be carried. Nothing is bought with it, and how much is required is fixed by the authority rather than here. posted against it is Rs 160.00/-, being 8.0 per cent of that exposure. So Rs 160.00/- of collateral carries Rs 2,000.00/- of exposure, 12.50 times over. The 8.0 per cent behind that Rs 160.00/- is an assumption and not a requirement of any kind. Real margin is set by clearing corporations under the framework of the Securities and Exchange Board of India at sebi.gov.in, it differs by contract and by day, and it moves. Note also that the margin is struck on the exposure at today's price of Rs 2,000.00/- rather than on the Rs 2,130.00/- agreed for the later date. The spot price does the work there too.

Two more words get swapped constantly, and the swap makes an arrangement look many times larger than it is, so the two belong apart. The notionalThe quantity a calculation is multiplied by, rather than an amount that changes hands. Naming it stops an arrangement being read as many times larger than the cash it produces. is the figure the arithmetic is multiplied by, and none of it moves. The exposureThe amount of the referenced thing a position actually stands on, valued at today's price. is what the position actually stands on at today's price. On one unit here they happen to be close together, but they are answering two different questions and later material in this sequence pulls them apart properly.

Which parts of this are set by an authority in India?

What this material does not answer

Two prices for one reference asset have now been set out, along with where the second one comes from. The next question is almost automatic, and it deserves a straight answer rather than a shuffle. Which way is the spot price going?

The arithmetic above does not answer that, and no rearrangement of it will. The expression holds a price today, a rate and a length of time, and not one of the three carries a direction. The gap between Rs 2,000.00/- and Rs 2,130.00/- is financing. Financing is a cost. A cost is not news.

The second question that follows understanding a mechanism is whether anybody should be doing it. The answer rests on something worth stating rather than leaving as a formality. Answering it would take a record of how the arrangement turned out over long stretches, for people in comparable positions, with likelihoods attached, and not one of those three things follows from the arithmetic of a carry. Understanding how a price is built is not a reason to transact at it.

Somebody would have to establish four things first: why the position is being held, what else sits alongside it, what collateral has gone in, and what falls due on the day settlement arrives. All four are what the rest of this sequence is about, and not one of them is a view about a price.

The reference asset, its spot price of Rs 2,000.00/-, the financing rate of 6.50 per cent a year, the carry of Rs 130.00/-, the price of Rs 2,130.00/- agreed for a date one year out, the two extra spot levels of Rs 1,600.00/- and Rs 2,400.00/- and the 8.0 per cent behind the Rs 160.00/- of collateral are invented.
Educational material. Not advice on any investment, tax, budget or market position.