Is the future price too high or the spot price too low?

How do spot prices compare to futures market prices? The difference between the two is 'the term'. Spot prices are prices for immediate delivery and forward market prices are prices for future delivery. The difference is therefore in the storage costs.

We translate this to the market for potatoes suitable for chips. Suppose you buy potatoes today for €12,50 per 100 kg, as PotatoNL notes on average (the spot price). Assuming €0,17 per week in storage costs, it will cost €5,10 to store the potatoes up to and including week 17, the expiry date of the April futures contract on the stock exchange. Then the futures market price should be €17,60 (€12,50 + €5,10), the calculated forward price.

Arbitrage
The closing price of the April 2022 futures contract is €1 on Friday, October 20,40. That's almost $3 higher than the price calculated above. That in itself is special. So you could sell the futures contract at $20,40. Then you have to deliver potatoes at the settlement price at the end of April 2022. So you can buy those potatoes now and store them until the end of April. As calculated above, this costs €17,60. You therefore include a profit of € 2,80 (€ 20,40-€ 17,60), as it were. This is called arbitration. It doesn't matter whether the price goes up or down. There always remains a profit of € 2,80.

The table below makes this clear and shows what happens if the price today ($12,50) falls to $6 or rises to $25 in April 2022:

Cash settlement contract
Now the practice is a little bit different. The forward contract is a cash settlement contract. It is settled in money at a price that the exchange determines: the cash settlement price. The question is whether you can also sell your physical potatoes at exactly that price, as happens above for €6 or €25. That is a risk in this model that can turn out to be advantageous or disadvantageous. But that risk can never be great.

Arbitration should ensure that prices cannot diverge too far, otherwise parties enter into risk-free transactions and earn money until prices are in line again. So what's wrong here? Is the futures market price too high? Is there too much sentiment in the price and are the buyers exaggerating? And shouldn't you be willing to pay more than €17,60? Or is the price for potatoes too low at the moment? And you can't get the right potatoes for €12,50, but do I have to pay €15,20 for them, which means that the 'risk-free profit opportunity' disappears or at least no longer exists?

The answer to this is difficult to give. Futures exchanges are transparent and the April 2022 contract is frequently traded daily. The quotations for physical potatoes such as PotatoNL and Belgapom do not come out of the blue, of course. The fact is that there are opportunities to take advantage of the existing situation.

Calculated forward prices
DCA-Markets calculates the calculated forward price for each delivery month remaining in the season up to July 2022. First, a spot price is calculated by calculating an average price from the quotations for chips potatoes in Germany, France, Belgium and the Netherlands. At that average price you should always be able to buy potatoes for immediate delivery. And if you were to store those potatoes, you would incur costs for the storage period. The current price plus the cost of the retention period makes the calculated forward price for the months remaining. For example, prices are now available for the months of October 2021 to July 2022.

You can view the calculated spot price and the calculated prices per month here find.

Questions about market developments? Contact René van 't Riet via info@dca-markets.com or +31(0)320 269 523.

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