What is a spot market?
Financial products, including stocks, currencies, and commodities, are exchanged on the spot market for instant delivery. Cash is exchanged for the financial instrument upon delivery. In contrast, a futures contract is predicated on delivering the underlying asset later.
Exchanges may provide spot, futures, and over-the-counter (OTC) markets.
How Spot Markets Work
Spot markets are sometimes known as “cash markets” or “physical markets” when deals are made instantly for the item. Both sides agree to the deal “right now,” even if the formal money transfer between the buyer and seller may take some time—T+2 in the stock market, for example, or longer in most currency transactions. A price is agreed upon upfront in a non-spot or futures contract, but the money is not delivered or transferred until later.
Since the expiring contract indicates that the buyer and seller will be exchanging cash for the underlying asset immediately, futures transactions in contracts that are about to expire are also sometimes referred to as spot trades.
Spot Cost
The spot price is the current cost of a financial product. It is the cost at which an instrument is available for instant purchase or sale. Buyers and sellers who publish their buy-and-sell orders set the spot price. When new orders enter the market and existing ones are filled, the spot price in liquid marketplaces may fluctuate minute by minute.
The term “spot” is derived from the expression “on the spot,” which refers to these marketplaces’ instantaneous asset purchases.
Exchanges and Spot Markets
Dealers and traders who buy and sell stocks, commodities, futures, options, and other financial instruments come together at exchanges. The exchange gives traders access to the exchange and the current price and volume based on all participant orders.
One exchange where traders purchase and sell equities for instant delivery is the New York Stock Exchange (NYSE). It’s a spot market here.
Trades in futures contracts are made on exchanges like the Chicago Mercantile Exchange (CME). This isn’t a spot market; this is a futures market.
Spot and Over-the-Counter sales
Over-the-counter transactions are those that take place directly between a buyer and a seller (OTC). A centralized exchange does not facilitate these transactions. With an average daily turnover of $5 trillion, the foreign exchange market, often known as forex, is the biggest over-the-counter market globally.
The price of an over-the-counter (OTC) transaction may be set based on a future date or a current price. Because the conditions of an OTC transaction are flexible, the buyer and seller may have the last say. OTC stock deals are usually spot trades, similar to exchange trades. However, futures and forwards are often not spot trades.
Illustration of a Spot Market
Assume that a German online furniture retailer gives all foreign buyers who pay for their orders a thirty percent discount within five business days of ordering them.
After seeing the offer, Danielle, a US-based online furniture retailer, buys $10,000 worth of tables from the online retailer. Taking advantage of the present EUR/USD exchange rate of 1.1233, Danielle purchases the equivalent of $10,000 in euros at the spot price, or €8,902.34 ($10,000/1.1233), as she needs to acquire euros for (nearly) immediate delivery. Danielle settled her account to get the 30% discount after receiving her euros in two days due to the spot transaction’s T+2 settlement period.
Benefits and Drawbacks of Spot Markets
The spot price is the current quotation for the immediate purchase, payment, and delivery of a particular item. This implies that it is crucial since these values will unavoidably form the basis for pricing in derivatives markets, such as futures and options. For this reason, spot markets also tend to be quite liquid and lively. Producers and consumers of commodities will participate in the spot market before hedging in the derivatives market.
Nevertheless, accepting the delivery of tangible goods is a drawback of the spot market. You now own some live pigs if you purchase spot pork bellies. A meat processing company could want this, but speculators most likely don’t. The ineffectiveness of spot markets as a hedge against future production or consumption of goods—a function better suited to derivatives markets—is another drawback.
Advantages
- The current pricing of the actual market
- Marketplaces that are liquid and active
- Upon request, accept delivery right away.
Cons
- Must often accept physical delivery
- Unsuitable for hedging
- FAQs about Spot Markets
What Does Spot Market Mean?
Spot markets deal with goods that may be delivered immediately or soon. The term “spot” describes a transaction in which a good is made “on the spot” and received.
What Kinds of Spot Markets Are There?
There are busy spot markets for several commodities where actual spot commodities are purchased and traded for cash in real-time. Spot currency markets are another kind of foreign exchange (FX) wherein the underlying currencies are physically swapped beyond the settlement date. Because money transfers between bank accounts often take two days, delivery usually happens two days following execution. Since company shares are exchanged in real-time on stock markets, they may also be compared to spot markets.
A Spot and Forward Market: What Is It?
In spot markets, commodities and other assets, such as currencies, are exchanged for cash and delivered immediately. Alternatively, trading futures contracts takes place in a forward market (for more information, see the following question).
What distinguishes futures markets from spot markets?
Derivatives contracts that utilize the spot market as the underlying asset are called forwards and futures. These are agreements that, for a sum agreed upon now, provide the owner with ownership of the underlying property at some future date. Physical delivery of the commodity or other item would only occur after the contracts expire, and traders often roll over or close out their contracts to avoid making or accepting delivery at all. In general, forwards and futures are identical; however, whereas futures are standardized and sold on exchanges, forwards are customizable and traded over the counter (OTC).
Conclusion
- In the spot market, financial products are traded for instant delivery.
- A “spot price” and a “futures or forward price” are quoted for many assets.
- The majority of spot market deals are settled on a T+2 basis.
- Spot market transactions may occur over-the-counter (OTC) or on an exchange.
- Derivatives markets, which deal in forwards, futures, or options contracts, might be compared to spot markets.
