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What Is a Spot Trade?
The term spot trade refers to the purchase or sale of a foreign currency, financial instrument, or commodity for instant delivery on a specified spot date. Most spot contracts include the physical delivery of the currency, commodity, or instrument to the buyer. In a foreign exchange spot trade, the exchange rate on which the transaction is based is referred to as the spot exchange rate. A spot trade can be contrasted with a forward or futures trade.
Key Takeaways
- Spot trades involve securities traded for immediate delivery in the market on a specified date.
- Spot trades include the buying or selling of foreign currency, a financial instrument, or a commodity.
- Many assets quote a spot price and a futures or forward price.
- Spot market transactions can take place on an exchange or over-the-counter.
Understanding Spot Trades
As noted above, a spot trade is a financial transaction that involves a commodity, foreign currency, or financial instrument. This type of trade is also commonly referred to as a spot transaction. These types of transactions can take place on an exchange or over the counter (OTC). For instance, commodities are often traded on exchanges while currencies are commonly traded OTC.
Foreign exchange spot contracts are the most common type of spot trades. They are usually specified for delivery in two business days, while most other financial instruments settle the next business day. The spot foreign exchange market trades electronically around the world. It is the world's largest market, with over $7.55 trillion traded daily. As such, its size dwarfs both the interest rate and commodity markets.
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 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 outstanding orders get filled and new ones enter the marketplace.
The difference in the 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 the time to maturity.
Special Considerations
The price for any instrument that settles later than the 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.
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 one business day.
Commodities are usually traded on an exchange. The most popular exchange is the CME Group 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 before maturity, and the gain or loss is settled in cash.
What Is the Spot Market?
The term spot market refers to a market that trades certain financial instruments for near-term or immediate delivery. These instruments include commodities, currencies, and other securities. Buyers and sellers normally exchange cash for the noted security in the spot market, which is why they're normally called cash or physical markets.
What Is a Spot Price?
A spot price is the current market price quoted for immediate delivery for a financial instrument, such as a currency, commodity, or interest rate. This is the price that traders pay when they want to take delivery for an asset right away. A spot price is used to determine future prices.
What's the Difference Between a Spot Rate and a Forward Rate?
Spot and forward rates are two prices used in the foreign exchange market. The term spot rate refers to the current market price quote for immediate delivery. Spot rates are used for currencies, commodities, interest rates, and other securities. A forward, rate, on the other hand, is a future price that two parties agree upon for a currency or other security.
The Bottom Line
Spot trading is the exchange of a financial instrument for immediate delivery on a certain spot date. Assets commonly traded in the spot market are currencies, commodities, and interest rates. Knowing some of the nuances of this market (spot prices, spot rates, and trends) and how it works can help you mitigate your losses and keep you in the black.