Spot market vs futures market

In this article we will provide you the information about Spot market vs futures market with major differences.

What is Spot Market?

In spot markets, transactions are generally settled within a day or two after the purchase/sale date. This is what is understood as a settlement in D+1 or D+2. Likewise, transactions are closed at the current price of the asset in question that exists at the time of the transaction. This is one of the main differences between the spot market and the futures market .

Therefore, we could define the spot market as a market of immediacy, in which we pay or receive money at the same moment in which we receive or deliver the merchandise or underlying asset in question.

Basically, the spot market corresponds to a market of immediate operations, when the parties involved enter into an agreement.

Therefore, when we buy a certain share of a company, for example, it is defined at that exact moment the amount to be paid, as well as the number of securities to be obtained.

From this negotiation, there is no going back. The money has already been paid, and the action belongs to us to negotiate in the best possible way!

What are futures markets?

One of the greatest concerns regarding any commercial operation is the search for formulas that reduce its multiple risks. Credit insurance is a good example , which drastically reduces the risk of default. Another example is the futures markets. Born in the 19th century, futures contracts or forwards emerged to protect raw material products, initially agricultural, against price variations.

Thus, futures markets emerge as an alternative to cash markets and their high price volatility, which occurred at the time the transition was made, mainly when the harvest ended and enormous changes could occur in both demand and supply. offer and with it in the prices.

Markets such as the Chicago Board of Trade , which emerged in 1848 in Chicago, where a good part of the grain operations in North America were concentrated, were the origin of today’s futures markets. Initially its activity focused on raw materials or agricultural commodities such as wheat or corn, but it has diversified into other products, including financial products.

How a future works?

The mechanism of operation of the first futures markets was simple. This was based on forward contracts that were configured as forward contracts between the parties, in which certain conditions were established such as the quantity, quality of the product and the price at an expiration date. For example, a corn contract at $181.50 per ton expiring in April 2022.

Through this system, the seller and the buyer always have a guaranteed purchase price . With respect to that price, three things can happen upon expiration: the market price is equal to the agreed upon price, higher (which represents a capital gain for the buyer and a capital loss for the seller) or lower (a capital gain for the buyer; capital gain for the seller). the seller).

What is the difference between Spot Market and Futures Market?

Although there are several differences between both markets, the main difference consists of the delivery of the underlying and the user’s use of the market. Below are the main differences:

• Temporary: Unlike the spot market in which the merchandise is generally delivered 2 days after the agreement, in the futures market this is postponed in time (30,60 or 90 days is the most typical depending on the underlying) . Therefore futures contracts have an expiration, which does not exist in the spot market.
• Physical delivery: Another difference related to delivery is whether the physical merchandise is delivered at the expiration of the contract or whether a settlement for differences is made. This does not exist in the spot market, since one expects to obtain the merchandise in exchange for the spot price paid. Only physical delivery is contemplated. However, in the futures market, in addition to physical delivery, settlement for differences is also contemplated.
• Greater degree of speculation: A final difference between both markets is that in the cash market, sellers and buyers come for a real need. The nature of these is less speculative than that of a futures market. Consequently spot markets are more connected to the real economy. A person goes to the spot market who needs, for example, to buy a currency other than their own because they are going on a trip. Another case may be that of a company that buys foreign currency in the spot market, because it has to pay for a commodity. However, purchases/sales in futures markets are sometimes made with the intention of obtaining a profit for the difference between the price agreed in the contract and the price of the underlying at expiration.