how spot markets work
spot markets are also referred to as physical markets or cash markets because trades are swapped for the asset effectively immediately while the official transfer of funds between the buyer and seller may take time such as t 1 in the stock market and in most currency transactions both parties agree to the trade right now 1 a non spot or futures transaction is agreeing to a price now but delivery and transfer of funds will take place at a later date futures trades in contracts that are about to expire are also sometimes called spot trades since the expiring contract means that the buyer and seller will be exchanging cash for the underlying asset immediately spot pricethe current price of a financial instrument is called the spot price it is the price at which an instrument can be sold or bought immediately buyers and sellers create the spot price by posting their buy and sell orders in liquid markets the spot price may change by the second or even within milliseconds as orders get filled and new ones enter the marketplace the word spot comes from the phrase on the spot where in these markets you can purchase an asset on the spot spot market and exchangesexchanges bring together dealers and traders who buy and sell commodities securities futures options and other financial instruments based on all the orders provided by participants the exchange provides the current price and volume available to traders with access to the exchange spot market and over the countertrades that occur directly between a buyer and seller are called over the counter otc a centralized exchange does not facilitate these trades the foreign exchange market or forex market is the world s largest otc market with an average daily turnover of 7 5 trillion as of april 2022 2in an otc transaction the price can be either based on a spot or a future price date in an otc transaction the terms are not necessarily standardized and therefore may be subject to the discretion of the buyer and or seller as with exchanges otc stock transactions are typically spot trades while futures or forward transactions are often not at the spot price unless they are nearing expiration example of a spot marketlet s say an online furniture store in germany offers a 30 discount to all international customers who pay within five business days after placing an order danielle who operates an online furniture business in the united states sees the offer and decides to purchase 10 000 worth of tables from the online store since she needs to buy euros for almost immediate delivery and is happy with the current eur usd exchange rate of 1 1233 danielle executes a foreign exchange transaction at the spot price to buy the equivalent of 10 000 in euros which works out to be 8 902 34 10 000 1 1233 the spot transaction has a settlement date of t 2 so danielle receives her euros in two days and settles her account to receive the 30 discount advantages and disadvantages of spot marketsthe spot price is the current quote for immediate purchase payment and delivery of a particular commodity this means that it is incredibly important since prices in derivatives markets such as for futures and options will be inevitably based on these values spot markets also tend to be incredibly liquid and active for this reason commodity producers and consumers will engage in the spot market and then hedge in the derivatives market a disadvantage of the spot market however is taking delivery of the physical commodity if you buy spot pork bellies you now own some live hogs while a meat processing plant may desire this a speculator probably does not another downside is that spot markets cannot be used effectively to hedge against the production or consumption of goods in the future which is where derivatives markets are better suited real time prices of actual market pricesactive and liquid marketscan take immediate delivery if desiredmust take physical delivery in many casesnot suited for hedgingspot market faqsspot markets trade commodities or other assets for immediate or very near term delivery the word spot refers to the trade and receipt of the good being made on the spot many commodities have active spot markets where physical spot commodities are bought and sold in real time for cash foreign exchange fx also has spot currencies markets where the underlying currencies are physically exchanged following the settlement date delivery usually occurs within 2 days after execution as it generally takes 2 days to transfer funds between bank accounts stock markets can also be thought of as spot markets with shares of companies changing hands in real time a spot market is where spot commodities or other assets like currencies are traded for immediate delivery for cash forward and futures markets instead involve the trading of contracts where the purchase is to be completed at a later date read on to the following question for more on this forwards and futures are derivatives contracts that use the spot market as the underlying asset these are contracts that give the owner control of the underlying at some point in the future for a price agreed upon today only when the contracts expire would physical delivery of the commodity or other asset take place and often traders will roll over or close out their contracts in order to avoid making or taking delivery altogether forwards and futures are generically the same except that forwards are customizable and trade over the counter otc whereas futures are standardized and traded on exchanges 3