Forwardation

We’re always on the lookout for the next great thing, and now we’re sure we’ve found it: pacamole. That’s right: guacamole made out of peas instead of avocados. It’s gonna be huge. And so, to capitalize on what we’re sure is going to be a run on peas, we went ahead and bought some pea futures. In other words, we bought a contract to buy a bunch of peas at a later date for a predetermined price. Not because we personally want the peas, but because we’re pretty sure we’ll be able to sell the contract for the peas at a much higher price than we bought it for.

Fast-forward a few months, and pacamole really hasn’t taken off the way we thought it would. In fact, our pea futures are close to maturing, and the price of peas is far lower than what we predicted. The spot price, or current market price, is lower than our futures amount. This phenomenon is known as forwardation: the price of a certain commodity is lower than the price of futures that haven’t matured yet.

We have a couple options here: we can sell our pea futures and likely take a loss. Or we can take delivery of the actual peas…and spend the rest of our days making pacamole.