What Is Spot Market And How Does It Work

Commodity spot market is where buyers and sellers engage in immediate trades. To put it simply, payment and delivery happens simultaneously. Visit multibank group

Commodity markets tend to vary from other financial markets such as stocks, bonds, mutual funds, and ETFs, that trade specifically via brokerages. Since they stand for a physical good, commodities have another market known as the spot market. It is a place where real commodities are purchased and sold.

On the contrary, futures markets have lengthier time horizons. Traders purchase and sell futures contracts on the basis of their speculation of the asset’s future price. Futures contracts started off in the farming industry. Farmers felt the need to protect their income against the unpredictable nature of crop yields given how irregular the weather patterns could be. Futures enable them to ensure that they will have a certain amount of income in advance.

It is prevalent even today in the case of people who create goods, prefer selling futures contracts so they are sure of a particular market price which their products may be bought for in the future. People who are buyers of these goods do purchase futures contracts as it allows them to predict the kind of money they will have to spend on particular commodities.

How Spot Markets Work

Spot markets are also known as “physical markets” or “cash markets” since trades can be exchanged in return for the asset immediately. Though officially, transferring funds among the buyer and seller might require more time, in a majority of currency transactions, both parties prefer immediate trades. A non-spot, or futures transaction, implies that you reach a consensus about the price in the present moment while the delivery as well as the fund transfer happens at a predetermined future date.

Futures trades in contracts nearing expiry may also be referred to as spot trade because expiring contracts also imply that the buyer and seller would be dealing with cash for the underlying asset.

Spot Price

An asset, commodity, or financial instrument’s present market price is known as spot price. It is the rate which a buyer would be obliged to pay the seller when they purchase a financial instrument. In a spot market, traders mutually reach a decision and agree on a certain rate for the commodities at the present moment and the commodities are also delivered right away.

A non-spot market is at the other end of the spectrum where traders decide on the rate of a particular asset or commodity at the moment while it is finally delivered on a later date. The present rate of financial instruments can differ from one market to another. They may even be affected by various market factors like in the case of a liquid market, the order flow could make a difference in the spot price.

Significance of Spot Market

Any asset’s spot market turns out to be important when it comes to price discovery. It’s believed to be a transparent and clear analysis of the realities of an economy.

It is because spot markets are typically more dependent on real buyers and sellers. Thus, they must offer a supply and demand picture with greater accuracy as compared to the futures markes which are rather speculative and subject to manipulation.

Spot Market and Over-the-Counter

An over-the-counter (OTC) trade takes place between a buyer and a seller. It is a direct trade which does not involve any intermediaries. In such a trade, spot trade is also a possibility should the buyers and sellers be able to connect in order to trade for assets right away. Trade agreements are predominantly made at OTC on the basis of trader’s discretion. The forex market is the largest OTC market all over the world which does not involve a centralized exchange between buyers and sellers of securities. Even in an OTC trade, buyers and sellers agree on a price with the help of spot price or a future price (date). Which implies that spot trade as well as futures contract trade can take place on over-the-counter trade.

Example of Spot Market

Take the case of spot and futures markets for precious metals.

Precious-metal prices which investors are able to access via financial news networks would typically be the present futures price established as per COMEX. It is an easy-to-quote market price. It’s the final sum of all futures trading that takes place in a single central exchange in a couple of different central exchanges.

The spot market is harder to understand. In the current scenario, the spot rate may be considered the average price a trader would prefer to pay for a particular ounce of gold or silver. This does not take into account the premiums that sellers might charge.

In some cases, the price between futures market and spot market turn out to be different and this difference is what one calls the “spread.” Under general conditions, ther difference may not be extremely high while in uncertainties, it might be rather extreme.

During the pandemic, there was a tense atmosphere around February and March 2020 as various governments imposed travel, as well as commercial restrictions, the gold and silver futures as well as spot market, spreads became wider. What worsened it was the fact that premiums were increasing well.

Silver’s lowest mark was when it was trading near $12 per ounce on the COMEX. The spot market for silver went two ways: one was them being sold out completely or going for double the rate of the futures market near $24 per ounce.

In that period, there were several futures contracts where people demanded physical delivery. It implied that a few people who owned the contracts wanted to be in possession of the physical metal. Know more

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An agreement such as this, has no room in the spot market because the market relies on physical exchange. With this instance, a buyer gives cash in return for the precious metal.

Pros and Cons of Spot Market