What is a Spot Trade
A spot trade is the purchase or sale of a foreign currency, financial instrument or commodity for instant delivery. Most spot contracts include physical delivery of the currency, commodity or instrument; the difference in price of a future or forward contract versus a spot contract takes into account the time value of the payment, based on interest rates and time to maturity.
BREAKING DOWN Spot Trade
Foreign exchange spot contracts are the most common and are usually for delivery in two business days, while most other financial instruments settle the next business day. The spot foreign exchange (forex) market trades electronically around the world. It is the world's largest market, with over $5 trillion traded daily; its size dwarfs the interest rate and commodity markets.
Spot trading most commonly refers to the spot forex market, on which currencies are traded electronically around the world. Most spot currency trades settle two business days after the execution of the trade, with the exception of the U.S. dollar vs. the Canadian dollar, which settles the next business day. Holidays can cause the settlement date to be far more than two calendar days after execution, especially during the Christmas and Easter seasons. The settlement date must be a valid business day in both currencies. Money generally changes hands on the settlement date, which means there is credit risk between the two parties.
The most commonly traded currency pair is the euro vs. the U.S. dollar, followed by the dollar vs. the Japanese yen. Currency pairs that do not include the U.S. dollar are referred to as cross currencies; the most commonly pairs are the euro vs. the yen or the British pound.
Spot trades are usually executed between two financial institutions or between a company and a financial institution. Spot trades can be undertaken for speculative purposes or to pay for goods and services.
Spot trading has become more widespread in the past 10 years because of the ease in trading with electronic systems and internet-based trading systems.
Other Spot Markets
Most interest rate products, such as bonds and options, trade for spot settlement on the next business day. Contracts are most commonly between two financial institutions, but they can also be between a company and a financial institution. An interest rate swap in which the near leg is for the spot date usually settles in two business days.
Commodities are usually traded on an exchange. The most popular are CME Group (previously known as the Chicago Mercantile Exchange) and the Intercontinental Exchange, which owns the New York Stock Exchange (NYSE). Most commodity trading is for future settlement and is not delivered; the contract is sold back to the exchange prior to maturity, and the gain or loss is settled in cash.
The price for any instrument that settles later than spot is a combination of the spot price and the interest cost until the settlement date. In the case of forex, the interest rate differential between the two currencies is used for this calculation.