Spot Market: Definition, How They Work, and Example

What Is a Spot Market?

The term spot market refers to the place where financial instruments are traded for cash for immediate delivery. Assets traded in the spot market include commodities, currencies, and securities. Delivery occurs when the buyer and seller exchange cash for the financial instrument. A futures contract, on the other hand, is based on the delivery of the underlying asset at a future date. Exchanges and over-the-counter (OTC) markets may provide spot trading and/or futures trading. 

How Spot Markets Work

Spot markets involve the exchange of physical securities for cash. This is why they are also referred to as physical markets or cash markets because trades are immediate. Both the buyer and seller agree to the immediate transfer of funds even though transactions settle on different schedules. For instance, a stock transaction settles on a T+1 basis or the business day after the transaction date.

Securities that are traded on the spot market include the following:

Futures trades in contracts that have an expiration date. They are also sometimes called spot trades since the expiring contract means that the buyer and seller will be exchanging cash for the underlying asset immediately.

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 or even within milliseconds, as orders get filled and new ones enter the marketplace.

Spot Market Trading

On Exchanges

Exchanges bring together dealers and traders who buy and sell commodities, securities, futures, options, and other financial instruments. Based on all the orders provided by participants, the exchange provides the current price and volume available to traders with access to the exchange.

• The New York Stock Exchange (NYSE) is an example of an exchange where traders buy and sell stocks for immediate delivery. This is a spot market.
• The Chicago Mercantile Exchange (CME) is an example of an exchange where traders primarily buy and sell futures contracts. This is a futures market and not a spot market. Although, CME does have some cash markets as well.

Over the Counter (OTC)

Trades that occur directly between a buyer and seller are called over-the-counter. A centralized exchange does not facilitate these trades. The foreign exchange market (or forex market) is the world's largest OTC market with an average daily turnover of $7.5 trillion as of April 2022.

In an OTC transaction, the price can be either based on a spot or a future price/date. In an OTC transaction, the terms are not necessarily standardized, and therefore, may be subject to the discretion of the buyer and/or seller. As with exchanges, OTC stock transactions are typically spot trades, while futures or forward transactions are often not at the spot price unless they are nearing expiration.

Advantages and Disadvantages of Spot Markets

Advantages

The spot price is the current quote for immediate purchase, payment, and delivery of a particular commodity. This means that it is incredibly important since prices in derivatives markets such as for futures and options will be inevitably based on these values.

Spot markets also tend to be incredibly liquid and active for this reason. Commodity producers and consumers will engage in the spot market and then hedge in the derivatives market.

Disadvantages

A disadvantage of the spot market is taking delivery of the physical commodity. If you buy spot pork bellies, you now own some live hogs. While a meat processing plant may desire this, a speculator probably does not.

Another downside is that spot markets cannot be used effectively to hedge against the production or consumption of goods in the future, which is where derivatives markets are better suited.

Example of a Spot Market

Let’s say an online furniture store in Germany offers a 30% discount to all international customers who pay within five business days after placing an order. Danielle, who operates an online furniture business in the United States, sees the offer and decides to purchase $10,000 worth of tables from the online store.

Since she needs to buy euros for (almost) immediate delivery and is happy with the current EUR/USD exchange rate of 1.1233, she executes a foreign exchange transaction at the spot price to buy the equivalent of $10,000 in euros, which works out to be €8,902.34 ($10,000 ÷ 1.1233). The spot transaction has a settlement date of T+2, so Danielle receives her euros in two days and settles her account to receive the 30% discount.

The Bottom Line

Financial markets are vast and take on different characteristics. The spot market is a type of financial market where buyers and sellers exchange assets for cash immediately. The price at which these assets are traded is called the spot price—the price for immediate sale. This is one reason why this market is also called a cash or physical market. Assets traded in the spot market include equities, fixed-income products, currencies, and commodities.