Difference Between Spot Market And Future Market: The financial market consists of various types of financial instruments which work differently from one another, and knowing how they work can help one make an informed decision.
These instruments commonly trade either in the spot market or in the futures market. Though both of these markets have significance to the individuals, they work in different ways.
In this article, we will discuss difference between spot market and future market.
What Is The Spot Market?
The spot market is a marketplace where you can buy and sell financial instruments on immediate delivery such as stocks, commodities, and currencies.
In other words, the spot market is where you buy or sell the financial instruments at the spot price they are trading at and the transaction amount is immediately settled between the buyers and the sellers.
In the spot market, the buyers would immediately receive the ownership of securities when the payment occurs and the sellers would immediately receive the cash.
The settlement of the buy and sell transactions in the spot market usually takes T+2 or T+1 working days. These spot market transactions can occur over the counter or through an exchange.
What Is The Spot Price?
Though the spot price is self-explanatory, knowing how the spot price is set is also an important part while investing or trading in the financial market. The spot price is the current price, at which a financial instrument can be immediately bought and sold in the market.
Spot prices get decided to depend on the demand and supply of the financial instrument.
Advantages Of Spot Market
- The transactions that occur in the spot market take place at the current price of the securities, which is public information and known to all the parties involved in the market. This creates transparency while trading the market
- Individuals in the spot market can hold on to their securities when they are not satisfied with the current market prices (they expect the market to move in their favour). They can execute their positions when they find better deals in the market
- Trades are executed and finalized immediately.
- The spot market does not require individuals to have a fixed amount of capital. Individuals can trade in the spot market with any amount of money and also purchase or short any quantity of a security
Disadvantages Of Spot Markets
- Trading in the spot market can pose a significant risk to individuals in a volatile market. Volatility in financial security can cause an inflated price for it, making individuals buy the securities at overvalued rates.
What Is The Futures Market?
The futures market is a marketplace where futures contracts are traded whose value is derived from an underlying asset price (Or spot Price).
These futures contracts are not executed immediately unlike the financial instruments in the spot market and get exercised at a specific date and a predetermined price.
What Is A Futures Contract?
A Futures contract is a financial instrument whose value is derived from an underlying asset. This is entered between the two parties, that is the buyer and seller at a predetermined price to be exercised at a specified date in the future.
This contract must be compulsorily executed at the time of expiry, irrespective of whether may make a profit or is incurring losses. However, rolling over your futures contract position to next month is allowed.
Advantages Of The Futures Market
- Futures contracts can be used by market participants to hedge their existing positions (in the cash market)
- As the futures market offers high liquidity, it allows future contract holders to enter and exit the contracts easily whenever they like.
- Futures contracts provide leverage to their participants. Meaning, they can enter a large position in the contract with a comparatively lesser margin and enables you to earn more profits
Disadvantages Of The Futures Market
- Though the futures market provides leverage and helps you maximize your profits, they also act as a double-edged sword which means your potential of incurring losses also increases
- As the contracts in the futures market are drawn for a specified period, individuals should execute the contracts before expiry even if they are in losses
Difference Between Spot Market And Future Market
Financial markets can be complex and understanding the differences between various types of markets can be critical for investors and traders to make informed decisions. Two of the primary markets in the financial world are the spot market and the futures market.
1. Price Determination
The price of the financial instrument in the spot market is derived from the demand and supply of the particular security.
In the case of the futures market, the value of the futures contracts is derived from the value of the underlying asset. Its price is based on the expected demand and supply the underlying asset is going to attain in the future.
2. Holding period
In the spot market, individuals can hold on to the financial instrument as long as they like and can execute them when they are in profit.
When it comes to contracts in the futures market, they must be compulsorily executed by both parties at a specified date and at a predetermined price.
A position in the spot market is created in order to benefit from the price difference while executing the contract. It cannot be used as an instrument to hedge your position.
A futures contract on the other hand is entered between the two parties at a predetermined price. Thus, the buyer will enter the future contract with the expectancy of the underlying asset increases in the future and the seller enters the futures contract with the expectancy of the underlying asset decreasing in the future.
4. Lot Size
Cash market instrument has no lot size and only one share can be bought or sold in the market.
But future contract trade only in lot size.
|Particulars||Spot Market||Future Market|
|Price Determination||Based on Demand and Supply||Based on the value of the underlying asset|
|Holding period||Can be held for any number of days||Can be held until expiry|
|Hedging||Cannot be hedged with another position in the spot market||Is used to hedge the price in the spot market|
|Quantity purchased||Can be purchased in any quantities||Can be only purchased as per the lots.|
In this article, we covered the meaning, advantages and disadvantages of spot and futures market, after which discussed the difference between spot market and future market.
The spot market and the futures market both have their unique set of features and investing in them have also comes with their own set of pros and cons. Before investing in one of these markets, individuals should access their goals and risk tolerance and make their decision wisely.
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