What’s it: Spot market is a market in which trading takes place for immediate delivery. Examples of spot markets are the market for securities, commodities, and foreign exchange (forex).
Ideally, delivery takes place a few seconds after completion of the transaction. However, in reality, it lasted more than twenty-four hours. In the spot forex and stock markets, immediate delivery means two business days. For commodities, that means in seven days.
Transactions take place on an exchange. However, some spot markets also take place over the counter. In a sense, transactions occur via telephone trading rather than on an organized exchange floor.
The current price of the traded goods is called the spot price. It is the price at which the item can be sold or purchased immediately. Buyers and sellers make up spot prices by posting their buy and sell orders.
Spot market features
- Trading can take place via an exchange or over-the-counter (OTC). The exchange represents a market where buyers and sellers are brought together. Meanwhile, over-the-counter only involves direct contact between the buyer and the seller, without going through the exchange.
- Item delivery and the transfer takes place as soon as the transaction is complete. It may take several working days.
- Spot price represents the actual price when the transaction is completed, not the future price. It applies immediately and not tomorrow.
- Spot price changes every day, depending on the supply and demand in the market. In contrast, in the futures contract, prices do not change until the delivery of goods and transfers of funds is complete.
- Requirements may be standard for transactions on exchanges. But, that may not be standard in over-the-counter transactions, depending on the buyer and seller’s agreement.
Difference between the futures market and the spot market
Spot market is in contrast to the futures market. Under the spot market, the parties involved agree on a current price, and delivery occurs immediately upon completion of the transaction.
Meanwhile, in the futures market, the parties involved agree on the current price. However, item delivery and funds transfers occur at a future date, even more than a few months after completion.
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Suppose an investor wants to buy shares and own them immediately. In that case, he goes to the spot market where they are traded, for example, on the Indonesian Stock Exchange or on the New York Stock Exchange. If you want to buy gold on the spot market, you can go to a gold coin dealer and exchange some cash for gold.
Determinants of the spot and futures market prices are also different. Usually, the difference between the two indicates the future price expectations, whether it will go up or down.
In the spot market, supply and demand are fundamental factors that affect prices. Meanwhile, prices in the futures market depend not only on these two factors but also on expectations of future prices, storage costs, and several other factors. For example, weather predictions also affect prices on the futures market for perishable commodities.
Examples of the spot market
Examples of spot markets are commodity markets, stocks, and currency markets.
Commodity markets transact various agricultural and mining products such as palm oil, coffee, tea, seeds, gold, oil, and natural gas. To be traded on the spot market, they must meet specific standards.
Take the spot oil market, for example. Market participants consist of crude oil producers, refiners, and large distributors or consumers of oil products. Trades take place by telephone, text, or via an online exchange.
Transactions are usually highly standardized, especially in delivery location, cargo delivery base (FOB or CIF), transportation mode, and transaction settlement period. Meanwhile, spot oil prices usually rely on publications from third party pricing agencies such as Platts.
Spot market for shares takes place on the Exchange, which brings together buyers and sellers. Examples are the Indonesia Stock Exchange for the Indonesian market and the New York Stock Exchange (NYSE) for the American market.
Foreign exchange market is the world’s largest financial market. Transactions per day reached an average of $6.6 trillion per day in April 2019, of which around $2 trillion were spot transactions. The actual transaction is completed 2 days after the trade has been agreed upon by the parties. Market participants mainly consist of commercial banks and world primary securities dealers.
Types of spot market
Spot markets can occur on an exchange or over the counter (OTC), depending on where the trade occurs. Exchanges bring together buyers and sellers in one place to make transactions and facilitate trade. Prices are determined based on the orders placed and offered by each party.
Meanwhile, the over the counter market occurs with a group of participants who do not have a central location. They contact each other to make transactions.
For this reason, over the counter transactions carry more risk. The source of risk comes primarily from a lack of reliable information. Also, in over-the-counter trading, market contracts are bilateral in nature. Each party can have credit risk issues concerning the other party.
Spot market advantages
Spot markets offer some advantages.
First, trading is more flexible than the futures market. Transactions on the spot market can run for lower volumes. Additionally, the parties involved can hold onto the item until they find a better deal.
Conversely, transactions on the futures market require a higher volume.
Second, deliveries are short-lived and require only a few. Therefore, the investor can immediately obtain the purchased item after paying a certain amount of cash. It reduces uncertainty and the possibility of counterpart delivery failure.
Third, spot markets usually require less capital. In contrast, in the futures market, the minimum investment is usually significant.
Fourth, prices are more transparent. You may use yesterday’s price to make a transaction now.
It is different from futures contracts. Because it involves a more extended timeframe in the future, the price can change significantly, so the uncertainty is high.