What does Back-pricing mean?
Sometimes seller and buyer find it more convenient to make futures contract without fixing the price in advance. They agree to sell and buy a commodity futures and also decide the price at a later date. The price in such a transaction is linked with some index or say average price of the two days prior to the delivery date. This pricing method is known as Backpricing.
Futures Knowledge Explains Back-pricing
Backpricing is a pricing method where the commitment to buy and sell is made in advance without fixing the actual price. The price is based on some formula which includes variations in markets during the in-between period. Backpricing reduces the risk and the actual transaction price is nearer to its fair market value on the delivery date.
Backpricing method is a useful tool for both producers and consumers. They can plan their operation. It reduces risk. For example, a factory can ensure it gets the raw-materials and its production are not interrupted. Delivery is confirmed. The price also is not discretionary; it is linked to some index.