What is Spot Trading?
A spot trade, also known as a spot transaction, is when a trader buys or sells a financial instrument, commodity, or foreign currency on a specific date (the spot date). A spot contract often involves the physical delivery of currency or commodity. Spot trading accounts for the time value of the share price paid which depends on the maturity and interest rates. In spot foreign exchange transactions, the rate at which changes occur is called the spot exchange rate. You can compare futures or forward trading to spot trading.
How are spot trades settled?
The most common spot trades are foreign exchange spot contracts, which are typically delivered within two business days (T+2). Many financial instruments settle the next business day. Forex markets or otherwise called ‘spot foreign exchange markets’ are traded electronically worldwide and it is the largest market in the world with over $5 million traded every day. By comparison, interest rates and commodity markets are much smaller.
The current price through which you can buy or sell a financial instrument is called its spot price. It is created after the seller and the buyer place a buy or sell order. Orders are filled immediately when new ones come into the marketplace. Therefore, spot prices change every second in liquid markets. Bonds, options, and most other interest rate instruments are also traded on the next day for spot settlement.
A spot trading contract is conducted between a company and a financial institution or between two financial institutions. In interest rate swaps, the near-term leg is usually for the spot date, which is often settled over two trading days. Additionally, commodities are also traded on exchanges, with the most common ones traded on the CME Group and the New York Stock Exchange.
Special considerations
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Forward price
The price of an instrument that settles later than the spot is a mix of the spot price and the interest value before the settlement date. For foreign exchange, this calculation uses the difference in interest rates between the two currencies.
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Other spot markets
Most interest rate products like bonds and options are traded on spot the next business day. A contract is usually between two financial institutions, but it may also be a contract between a company and a financial institution. Interest rate swaps with the nearest spot date are typically settled within two business days.
Commodities are typically traded on the exchange. The most popular ones are the Intercontinental Exchange, which owns the New York Stock Exchange (NYSE), and the CME Group, formerly known as Chicago Mercantile Exchange. Most commodity transactions are for future settlements and are not delivered. The contract is sold back to the exchange before maturity and the profit or loss is paid in cash.
How market exchanges work
Spot exchanges include the New York Stock Exchange (NYSE) and the CME – these exchanges bring together traders and dealers who sell or buy securities, futures, commodities, options, and other financial instruments. Exchange participants place orders to buy or sell securities at spot prices.
Based on all orders placed on a specific date, the exchange acts as a platform providing the current trading volume and stock price to market participants. The New York Stock Exchange (NYSE) allows traders to buy and sell stocks, making it a pure spot market. CME, or Chicago Mercantile Exchange, on the flip side, is where you buy and sell futures contracts. Therefore, CME is a futures market, not a spot market.
Exchange market vs. Over the counter (OTC)
Spot markets like foreign exchange are open exchanges. However, centralized exchanges as markets do not cover all spot trading. Examples of spot transactions can also be seen directly between buyers and sellers called over-the-counter spot trading. Unlike Forex and other forms of market trading, OTC trading is decentralized.
In these trades, the share price is based on a future date/price or the spot price. The trading conditions are not necessarily standardized. Accordingly, such transactions are generally at the discretion of the buyer or the seller. Like exchanges, over-the-counter trading is usually a spot trade.
Final word
The spot market is for spot trading, where financial instruments are traded for immediate delivery. Spot tradable assets quote a spot price (current trading price ) as well as a forward price, which will eventually be their future trading price. These trades can be decentralized without intermediaries or take place on publicly traded exchanges such as the NYSE.
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Frequently Asked Questions
Spot trading in India is considered an accurate system for both parties to negotiate and compete. Both buyers and sellers start a price competition and offer the best price to both parties. It is well regulated and very transparent, so there is no risk of illegal trading.
In commodities markets, the spot rate is the current price for a product that will be traded instantly or "on the spot." A forward rate, on the other hand, is a contracted price for a transaction that will be completed at an agreed-upon date in the future. Although in bond markets, forward rate refers to the future yield based on interest rates and maturities.
You calculate the forward rate by multiplying the spot rate by the ratio of interest rates and adjusting for the time until expiration. So, the forward rate is equal to the spot rate x (1 + domestic interest rate) / (1 + foreign interest rate).