The spot market is a financial hub where commodities, currencies, and securities are traded for immediate delivery. Delivery essentially entails the exchange of cash for the financial instrument. In contrast, a futures contract hinges on the delivery of the underlying asset at a future date.
Exchanges and over-the-counter (OTC) markets may offer platforms for spot trading as well as futures trading.
Key Takeaways
- Financial instruments are traded for immediate delivery in the spot market.
- Multiple assets quote a ‘spot price’ and a ‘futures or forward price.’
- Most spot market transactions have a T+2 settlement date.
- Transactions can occur on either an exchange or OTC.
- Spot markets are contrasted with derivatives markets that trade in forwards, futures, or options contracts.
How Spot Markets Work
Spot markets, also referred to as ‘physical markets’ or ‘cash markets,’ involve trades swapped for the asset almost immediately. While the actual transfer of funds may take a bit longer, such as T+2 in stock markets or most currency transactions, both buyer and seller agree to the trade instantaneously. Futures trades nearing expiration may also be considered spot trades due to their imminent cash exchange.
Spot Price
The spot price is the prevailing price at which a financial instrument can be bought or sold at the moment. The spot price is dynamic and is influenced by the ongoing buy and sell orders. In highly liquid markets, this price can fluctuate by the second or even within milliseconds.
Spot Market and Exchanges
Exchanges act as platforms for dealers and traders to buy and sell various financial instruments. Based on the orders from participants, the exchange determines the current price and available volume.
- The New York Stock Exchange (NYSE) facilitates immediate stock trading, classifying it as a spot market.
- The Chicago Mercantile Exchange (CME) primarily deals in futures contracts but also contains some spot markets.
Spot Market and Over-the-Counter
Trades occurring directly between buyer and seller without the mediation of a centralized exchange are termed OTC transactions. The foreign exchange market (forex) stands as the largest OTC market globally, with significant daily turnover. OTC market terms can vary, being defined at the seller’s and buyer’s discretion.
Example of a Spot Market
Consider a scenario where Danielle, an online furniture seller in the U.S., spots a German furniture store offering a 30% discount for users who complete payments within five business days. With a favorable EUR/USD exchange rate, Danielle executes a spot transaction for immediate forex trading, purchasing euros equivalent to $10,000. The deal’s settlement occurs in two days, qualifying her for the discount.
Advantages and Disadvantages of Spot Markets
The listing spot price reflects the current market dynamics and is pivotal for derivatives market prices. Spot markets often boast high liquidity and activeness.
Advantages
- Prompt access to real-time market prices.
- Active and liquid markets.
- Immediate purchase and delivery opportunity.
Disadvantages
- Obligation to take physical delivery in numerous cases.
- Limited suitability for future hedging, unlike derivatives markets.
Spot Market FAQs
What Does Spot Market Mean?
Spot markets trade in commodities or other assets for quick delivery. The term ‘spot’ highlights the instant trade and receipt of goods.
What Are Examples of Spot Markets?
Spot markets exist for various commodities, foreign exchanges, and the stock markets. Physical exchange of underlying assets usually happens within two days post-transaction.
What Is a Spot and Forward Market?
A spot market deals in immediate trades with prompt delivery. Conversely, forward and futures markets involve contract-based trades with future delivery periods.
What Is the Difference Between Spot Markets and Futures Markets?
In futures and forward markets, derivatives contracts regulate the trade of the underlying assets at future dates, with prices agreed upon today. Unlike customizable forwards, futures are standardized and traded on exchanges. Physical delivery occurs only upon contract expiration; otherwise, traders typically roll over or close their contracts to avoid physical exchange.
Related Terms: futures market, OTC market, spot price, derivatives.
References
- Bank of International Settlements. “OTC Foreign Exchange Turnover in April 2022”.
