Spot contracts definition

 

Whereas forward and futures contracts come in the form of orders placed in advance for future delivery, spot agreements are day-to-day exchanges of assets at the current market rate with an immediate conclusion that require the persons concerned to have the necessary resources at the ready to prevent delays.

 

While they are live indicators of the state of supply and demand, spot delivery contracts are rarely as rapid as their name suggests, given that deliveries are more often than not deferred, taking up to 48 hours to be honored.

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Faster spot transactions

 

Thanks to an ever-increasing digitalization of the very core of the trading world, systems like the RTGS (Real-Time Gross Settlement) help reduce the transaction time involved in wiring funds from a banking institution to another.

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Today's top spot markets

 

There are three majors markets today where most spot transactions occur, namely:

 

• The raw material market:

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While deliveries are known to take between one to two full working days, purchasing a commodity like crude oil at the ongoing market rate (spot price) allows buyers to circumnavigate price fluctuations and better adjust their trading strategy. What applies for oil also does for other listed raw materials - gold and silver being popular ones, for example -, as well as agricultural goods.

 

• The stock market:

 

Shares, bonds, investment funds, subscription warrants, structured products, etc.: on large financial centers, both the purchasing and selling of securities are handled momentarily to better curb delays between payment and delivery. However, shareholders are often met, as for other spot transactions, with a 2-day-maximum setback.

 

• The foreign exchange market:

 

On the Forex, currencies are exchanged by banking establishments in real-time. Both purchases and sales are conducted at the rate prevailing on the transaction date, but yet again, usually subject deliveries to delays, which fortunately do not exceed two working days either.

 

By now, you will have most likely understood that with these types of spot contracts, prices are subject to change, dictated by market behavior and orientation. Some assets and commodities, more than others, are prone to be more noticeably volatile. On futures markets, however, the period running between the placement of an order and the day the transaction is completed, allows financial actors more time to breathe and an occasion to mitigate risks.

 

What are futures contracts?

 

Simply put, when the delivery of goods happens sometime after payment completion, you are dealing with a futures contract. Now, when it comes to financial markets, the price of an asset bought on the spot may not match the one you would get out of a futures contract. This difference between spot and futures prices has its reasons, as futures markets revolve around two derivatives categories:

 

• Futures contracts.

• Forward contracts.

 

These two derivatives characterize commitments made to purchase or sell assets at a postponed date with an agreed-upon settlement price officialized by a contract. What differentiates the futures from the forward is that the former, standardized, is supervised by a clearing agency acting as an intermediary, when the latter is traded over-the-counter, that is, without any arbitrating mediator.

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Spot and forward transactions

 

With fast-changing rates and a high volume of traders, riding out the storm may prove challenging for spot trading. Unlike spot contracts, which hastily call to action, futures present investors looking for assets with risk-free rates meant to safeguard their purchase until the associated contract is due to expire.

 

Regarding futures contracts, investors are given two ways to go about trading: 

 

The first option grants them the right to purchase the desired asset and hold it until the expiration of the attached contract; the second leaves it to the investors, bound by respective contractual terms, to commit to purchasing the asset concerned once said contract runs out.

 

While in both cases an investor remains the rightful proprietor of the asset for as long as the contract remains valid, the former option forces them to part ways with their money much sooner than the latter, generally resulting in a shortfall in need of recovering. On the other hand, temporizing through risk-free rates until the conclusion of the contract promises better prospects of higher interest rates.

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Spot and futures prices: know the difference

 

The difference between the two is determined by the calculation of what is known as "forward points". Depending on what the asset or commodity at play and the economic context are, traders are met with either one of the two situations:

 

• Backwardation: the current price of an underlying asset is higher than the prices displayed in the futures market.

• Contango: the futures price of a commodity is higher than the spot price.

 

Taking the risk-free interest rate into account is of the essence here, and futures transactions heavily rely on this opportunity cost consideration. There are, of course, a myriad of multiple factors involved in properly conducting spot trading. Need some help with it? Hit us up and we will find you a speedy and reliable broker in no time for all your transactions!