What is a Spot Market?
The spot market is where financial instruments, such as commodities, currencies and securities, are traded for immediate delivery. Delivery is the exchange of cash for the financial instrument. A futures contract, on the other hand, is based on the delivery of the underlying asset at a future date.
Exchanges and over-the-counter (OTC) markets may provide spot trading and/or futures trading.
Spot Market Explained
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+2 in the stock market and in most currency transactions, both parties agree to the trade “right now.” 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.
The current price of a financial instrument is called the spot price. It is the price at which an instrument can be sold or bought at 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, as orders get filled and new ones enter the marketplace.
Spot Market and Exchanges
Exchanges 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.
The New York Stock Exchange (NYSE) is an example of an exchange where traders buy and sell stocks. This is a spot market.
The Chicago Mercantile Exchange (CME) is an example of an exchange where traders buy and sell futures contracts. This is a futures market.
Spot Market and Over-the-Counter
Trades 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 is the world's largest OTC market with an average daily turnover of $5 trillion.
In 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 spot.
- Financial instruments trade for immediate delivery in the spot market.
- Many assets quote a “spot price” and a “futures or forward price.”
- Most spot market transactions have a T+2 settlement date.
- Spot market transactions can take place on an exchange or over-the-counter.
Real World Example of Dealing in the Spot Market
Let’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.