What is spot?
Looking for a spot definition? Well, in trading terms, a spot price is the market’s current price – the price at which a particular commodity, currency or security can be sold or bought for prompt delivery. Spot prices are always unique to the time and place where they are being held; that said, with the nature of the global economy, spot prices tend to be quite similar worldwide. The spot market is also known as the cash market and is a form of financial market where commodities and financial instruments can be traded for immediate delivery.
In contrast to the spot market and prices are futures markets (or futures, as they are more commonly known). A futures price is the commodity or instrument in question’s expected value at a future date. A spot settlement usually takes place in T+2 working days, whereas, with a future contract, a specific date and time in the future is set for the transaction.
Where have you heard of spot?
Spot price is most commonly referenced in affiliation with the price of a futures commodities contract, particularly in the oil, agriculture or mining industries. This is because the price of a futures contract is usually worked out using the spot price of a commodity. It can also be worked out by habitual changes in supply and demand, the risk-less-return rate for the commodity holder, and the storage and transportation costs in relation to the end date of the contract. Therefore, a futures contract with a longer maturity date will have a more expensive storage cost than a soon to expire contract. A spot market can subsist through an exchange or an over-the-counter transaction (OTC) and can run wherever there is an infrastructure to carry the transaction.
What do you need to know about spot?
Spot prices tend to be extremely volatile. Spot prices of currencies and commodities are very important in terms of the immediate buy and sell transactions culture, and this should be respected.
It may, however, be more more critical to regard the multi-trillion dollar derivatives market. Futures contracts, options and other derivatives allow the buyers and sellers of commodities or securities to hold a precise price for a future point that has been chosen to make the transaction. These derivatives allow sellers and buyers to partly reduce the risk inflicted by regularly varying spot prices. Most of the time there is a significant difference between a spot price and a futures price. The most noted relation between the two prices, known as a normal market, is where the futures contract prices get progressively higher over time, in comparison to the current spot price. These high prices associated with futures contracts are usually accredited to carrying costs, such as storage risk due to the doubt of future supply and demand states in the marketplace, as well as the fact that goods prices tend to increase over time.
The graph below illustrates the price volatility in the commodities of food and metals:
The graph below shows the difference in spot prices and futures prices of natural gas:
Depending on the item that's being traded, a spot price can point towards market expectations of future price movement. For example, a security or non-perishable commodity’s spot price, like gold, displays the market’s expectations of future price migration.
Practically, the spot and futures price should have a difference that's equal to the finance charges and any earnings outstanding to the holder of the security, in line with the cost of carry model. For example, in regards to a share, the price difference between the spot and the forward is commonly considered entirely for the dividends payable in the span minus the interest payable on the purchase price. Any other sort of cost price would bring an arbitrage opportunity and risk free profit.
In comparison, a perishable commodity (also known as a soft commodity) doesn't grant this arbitrage, as the storage cost is higher than the expected futures price of the commodity in question. Because of this, a spot price show the current supply and demand, not the predicted future price migration.
In financial terms, the spot date is the day that the transaction takes place, usually as soon as possible – essentially ‘on the spot’. This type of transaction is referred to as the spot date and also simply as spot. The spot can be different for various types of transactions. In the Forex, the spot date is usually two banking days forward for the traded currency pair. A standard settlement date is worked out from the original spot date. For example, if today were 1 August, the spot date would be 3 August and the one month date would be 3 September (providing that all these dates are business dates). If a trade has two dates, for example a foreign exchange swap, then the first date is taken as the spot date. Below are some example of other kinds of spots.
The simplest way to explain this transaction is with an example. The price of apples is cheap in June and will be expensive in December, but you can't buy your apples for December in June as they are perishable goods and they will be spoilt by December. The price of apples in June reflects their value in June alone and their forward price in December reflects the market’s expectations of supply and demand in December. The apples are effectively different commodities in June than they are in December.
These rates are determined using the bootstrapping method. This uses the price of the securities currently being traded on the market from the coupon or cash curve. This results in a spot curve that occurs in various types of securities.
This is referred to as a foreign exchange spot or FX spot and is an acknowledgement by two parties to purchase one currency vs selling another currency at a set price for settlement on the spot date.
The spot and futures markets are opposites in many ways. The spot market exists for commodities and securities that are traded on the spot, with specific spot rates, as opposed to the futures market,s which is an auction based market used to buy and sell financial instruments at a specified later date. In a spot market the orders and prices are also referred to as spots because of their immediacy (all transactions are sorted there and then) whereas the futures markets are based on the buying and selling of future commodities. The spot rate, also known as the spot price, is the price quote for the prompt settlement on a security, commodity or currency. In transactions involving currencies, the spot rate is swayed by the interest of businesses and individuals in addition to that of forex traders. The spot rate refers to currencies but also to assets including bonds and commodities.
Where can you find out more about spot...
Our glossary has some very useful information on the topics involved in spot and the stock market in general. Take a look at our page for soft commodity or for the foreign exchange market. If you want to go into the details of all things spot then The Financial Times’ Guide to Investing is a great book to read.