What is Spot Market?

Example

WTI or Brent Crude oil is traded at the spot price, but the delivery is done only after a month. Since it is a commodity, the delivery usually takes time. Whereas in the case of stocks, it is delivered immediately once the payment is made and the ownership is transferred.

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Types of Spot Market

The cash market can be either exchange-traded or traded over the counter. It depends on where the trade takes place. Exchange brings together buyers and sellers in one place and facilitates trading. In contrast, an over the counterOver The CounterOver the counter (OTC) is the process of stock trading for the companies that don’t hold a place on formal exchange listings. The broker-dealer network facilitates such decentralized trading of derivatives, equity and debt instruments.read more trade happens with a closed group of participants that does not have a central location.

#1 – Exchange-Traded

  • Exchange provides the spot rate at which the securities are traded.Buyers and sellers of financial securities are brought together at a central place in exchange.Trades done via an exchange carry limited risk compared to trades executed over the counter due to the less risk of a counterparty defaulting.

#2 – Over Counter

  • Over the counter, trades are carried out between a limited group of counterparties.Over the counter, trades weigh more risk than trades.The trades executed over the counter are usually traded at the exchange rate.

Examples of Spot Market

Example #1

John owns a fabric business in New York and is looking for suppliers dealing with good quality fabrics at a competitive rate. He looks upon the internet and finds a Chinese supplier giving almost 40% discount on bulk orders of over $ 10,000. Of course, the payment needs to be made in CNY, and John might save big if the current market rate for USDCNY is high.

He checks the current USD CNY rate, which is 7.03, higher than the usual value. But looking at the discount the supplier is giving, John decides to execute a foreign exchange to convert the CNY equivalent of $10,000.

  • USDCNY = 7.03Purchase amount = $ 10,000CNY amount = $ 10,000 * 7.03CNY Amount= 70,300

The foreign exchange spot transaction settles or is delivered after two days (T+2), and John can make the payment, which allows him 40% savings on his purchase.

Example #2

Steve is looking to invest $ 5,000 in the stock marketStock MarketStock Market works on the basic principle of matching supply and demand through an auction process where investors are willing to pay a certain amount for an asset, and they are willing to sell off something they have at a specific price.read more but is unsure how he should start. He starts a Demat account with one of his trusted banks and checks into the various stocks traded over the market. Due to the fear of losing his money, Steve is interested in putting his money only into the blue-chip stocksBlue-chip StocksBlue chip stocks are issued by companies possessing large market capitalization. Blue chip companies are market leaders. They provide good returns on stocks, offer dividends, and are considered safe investments.read more. He buys 100 shares of Apple at $ 200.47. He makes the payment for it and hastens shares of Apple in his account; the spot market also allows immediate settlement. It allows Steve to get ownership of Apple shares on the same day. Steve also looks for other penny stocksPenny StocksPenny Stock refers stocks of public companies that trade at a very low price, typically less than $5 per share and are highly illiquid. Usually, these stocks belong to small and newbie companies with a low market capitalization.read more, which he thinks might become a good performer. He invests $ 2,000 in two different penny stocks.

Now, Steve has $ 1,000, and he decides to invest in currenciesInvest In CurrenciesInvesting in currency means purchasing one currency while selling the other pair or leg. This is accomplished through the Foreign Exchange market, also known as Forex. Spot trading, forward trading, and future trading are the top three ways to invest in currency.read more. He looks at the market trends and invests in the Chinese yuan expecting it to go up due to the news surrounding China’s economic growth. He assumes the Chinese Yuan to perform well in the long term and invests the remaining $ 1,000 in currency.

The trade settles in 2 days, and the account will be delivered with the Chinese Yuan.

Essential Points about Spot Market

  • Unlike a spot tradeSpot TradeSpot trades are immediate transactions that involve the trading of commodities and financial instruments.read more, a futures contract gives the investor the obligation to buy or sell the financial security at a pre-agreed price and a future date.Money changes hands later that futures prices demonstrate where part of the market expects the price of an asset to go while the spot price is the price at that moment.A futures transaction, in which a commodity is expected to be delivered or settled in less than a month, is also part of the cash market. It may have been sold at the spot price, but the ownership is transferred only at a future date, not immediately.Local regulations regulate the physical market.The price quoted for a purchase or sale on a spot market is the Spot PriceSpot PriceA spot price is the current market price of a commodity, financial product, or derivative product, and it is the price at which an investor or trader can buy or sell an asset or security for immediate delivery.read more.

Advantages of Spot Market

Some of the advantages are as follows.

  • The spot market is more flexible than a futures market since they can be traded on lower volumes (1,000 units). In contrast, a futures market requires higher volumes (usually 100,000 units, except very few instruments).This type of market is quick, and the delivery is usually two days.A spot market is straightforward, unlike a futures market.The physical market facilitates immediate trading with a transfer of funds and ownership quickly.Traders most favor it due to its flexibility and ease of trading rather than the futures market, which can be complicated and time-consuming.

Conclusion

  • When security is bought or sold and settled or delivered immediately, it refers to a physical market transaction.Contracts bought or sold in the spot market are immediately effective.A physical market is different from a futures market since the money is exchanged immediately.It allows the immediate transfer of ownership of securities.

This article has been a guide to the spot market and its meaning. Here we discuss examples of the spot market and its components and advantages. You can learn more about financing from the following articles –

  • Forward MarketOTC MarketSpot RateShare Market