Spot Market: What Is It?
The spot market is a public financial market in which financial instruments are traded for immediate delivery, like currencies, commodities, and securities. The transaction that officially transfers cash in return for the financial instrument is known as delivery. In contrast, the premise of a futures contract is that the underlying asset will be delivered at a specified future time and place.
Over-the-counter (OTC) marketplaces and exchanges may offer spot trading and/or futures trading.
Workings of Spot Markets
Spot markets are also known as "physical markets" or "cash markets" because deals are almost instantly exchanged for the underlying item. Both parties agree that the deal will take place "right now," although the official transfer of funds between the sellers and buyers may take some time (T+2 in the share market and most currency transactions). In a non-spot transaction, also known as a futures transaction, the buyer and seller agree on a price immediately, but the delivery and transfer of funds only occur later.
Spot trades are another name for futures trades that include contracts about to expire. This is because the expiration of a contract implies that the sellers and buyers will exchange cash for the underlying asset soon after the deal ends.
Spot Price
Spot price refers to the current market value of a financial instrument. It is the price for a security to purchase or sell immediately. By submitting their respective purchase and sell orders, buyers and sellers collaborate to establish the spot price. Because existing orders are fulfilled, and new ones are placed, the spot price in liquid markets may move significantly from one second to the next.
Spot Market and Exchanges
In order to facilitate the trading of commodities, currencies, futures, and other financial instruments, exchanges serve as a meeting place for dealers and traders. The exchange supplies the current price and volume, which is dependent on all of the orders that participants submitted. Traders who have access to the exchange can use this information.
● One such market where stocks are traded for immediate delivery is the New York Stock Exchange (NYSE). This particular market is known as a spot market.
●Market participants may purchase and sell futures contracts on exchanges like the Chicago Mercantile Exchange (CME). This is a futures market, not a spot market.
Spot Market and Over-the-counter
Trades that occur between a buyer and a seller without the involvement of a third party are Over-the-counter (OTC).
When doing a transaction over the counter (OTC), the price may be determined by either the spot price or a future price and date. Unlike in a regulated market, the parties to an over-the-counter (OTC) transaction are not bound by any particular set of rules when negotiating the parameters of the deal. In the same way, as exchange trades are spot trading, over-the-counter (OTC) stock deals are often spot trades, although futures and forward contracts are typically not spot trades.
Spot Markets: Pros and Cons
When referring to a commodity, the "spot price" is the current price at which that commodity may be bought, paid for, and delivered immediately. This indicates that it is of the utmost significance since pricing on derivative instruments, such as those for futures and options, will always be based on these values. Because of this factor, spot markets have a reputation for being very liquid and lively. The spot market is where producers and consumers of a commodity transact, with the derivatives market serving as a secondary risk-management venue.
The need to take delivery of the actual product is one of the drawbacks of trading on the spot market. Spot markets also have the disadvantage of being unsuitable for hedging against the future production or consumption of products, an activity that is better suited for the derivatives markets.
Pros
● Actual market prices as they are updated in real-time
● Markets that are both active and liquid
● If required, can accept quick delivery.
Cons
● Many items need a physical delivery.
● Not suitable for use as a hedge
What Differentiates Spot Markets from Futures Markets, and How Do They Work?
Derivative transactions such as forwards and futures are based on the spot market. These are agreements that, for a certain future payment, will allow the current owner the right to use the underlying asset at a specified future time. Physical delivery of the commodity or other item would only occur once the contracts expire. However, traders may often roll over or close out their agreements to avoid making or accepting delivery of the asset completely. Forwards and futures are essentially the same, except that forwards are fully customizable and may be sold over-the-counter (OTC), while futures are standardized and can only be exchanged on regulated exchanges.
