What is Spot Market?
Spot Market, also known as “physical market” or “cash market” is a financial marketFinancial MarketThe term "financial market" refers to the marketplace where activities such as the creation and trading of various financial assets such as bonds, stocks, commodities, currencies, and derivatives take place. It provides a platform for sellers and buyers to interact and trade at a price determined by market forces. where financial securities like stocks, currencies, commodities are bought and sold for immediate delivery. Most of the spot market trades are settled or delivered on two business days after the trade date (T+2) but many of the counterparties opt for settlement ‘right now’. The settlement price or the rate is called the spot price. An investor who wishes to own stocks of a company immediately will buy the stock which will allow him/her to own the stocks with immediate effect.
WTI or Brent Crude oil is traded at the spot price, but the delivery is done only after a month or so. 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 gets transferred as well.
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. trade happens with a closed group of participants which 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 when 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
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. 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 USDCNY rate, which is 7.03, which 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 = 7.03
- Purchase amount = $ 10,000
- CNY amount = $ 10,000 * 7.03
- CNY Amount= 70,300
The foreign exchange spot transaction settles or is delivered after 2 days (T+2), and John is able to make the payment, which allows him 40% savings on his purchase.
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. but is unsure of 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 refer to the stock of large stable companies having market capitalization in billions that provide a good return on stocks, may provide dividends, have less risk and are considered to be safe investments. Examples of such stocks include Coca-Cola ltd, IBM Corp, Boeing Co., PepsiCo, General Electric (GE), Intel, Visa, Wal-Mart, IBM Corp, Apple, Walt Disney, Mc Donald’s, Goldman Sachs, Johnson & Johnson, etc.. He buys 100 shares of Apple at $ 200.47. He makes the payment for it and has 10 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., which he thinks might turn up into 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.. 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 hence 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 trade, 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 at a later date 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, which is not immediate.
- Local regulations regulate the physical market.
- The price quoted for a purchase or sale on a spot market is called as 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..
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, the exception in very few instruments).
- This type of market is quick, and the delivery is usually with two days.
- A spot market is straight forward, unlike a futures market.
- The physical market facilitates immediate trading with a transfer of funds and ownership in a short period.
- Traders most favor it due to its flexibility and ease of trading rather than the futures market, which can be complicated and time-consuming.
- When security is bought or sold and then 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 what is spot market, and it’s a meaning. Here we discuss examples of the spot market along with its components and advantages. You can learn more about financing from the following articles –