3. What are spot trading and futures trading?

SPOT

Spot trading refers to transactions that take place on the spot markets, where buyers and sellers need to deliver goods immediately or within a few days after closing the deal. 

In mature financial markets, most spot transactions generally implement the so-called “T+2” settlement. For example, stock trading is mostly settled in two days after the transaction. However, spot trading does not necessarily have to take place in a specific time and place, and the transactions that occurred off-exchange markets are also called OTC (Over-the-Counter). An OTC transaction is one in which a buyer and a seller negotiate without going through an exchange or any other intermediaries. An OTC transaction does not need to be processed through a central exchange floor as in the stock market. A very good example of OTC is the Spot gold market. 

 

To put it simply, spot trading is the most traditional and direct way of trading, just like what happens in a bazaar or souk. 

 

Futures trading is the counterpart of spot trading, and futures are also developed on the basis of spot trading. The so-called futures trading is that the buyer and the seller agree to buy and sell a certain asset or commodity with a specific quantity and quality at a certain time and place in the future according to the contract terms and transaction price. 

 

Most of the early players in futures markets were producers, wholesalers, and retailers of certain commodities. The trade originated in the Japanese rice market in the 16th century and has since spread to the world. Due to the uncontrollable supply of commodities (including man-made, natural, economic environment, etc.), the price of commodities is prone to fluctuations. Buyers and sellers of some commodities want to lock the future prices as a hedge against future fluctuations, which is the original intention of futures trading. 

 

Futures markets not only facilitate the business of all parties involved but also effectively balance the unstable supply and demand in the market, so as to prevent unnecessary losses to buyers or sellers causing by volatile prices.  

  

Hedging/arbitrage can be carried out between spot and futures markets. Merchant A, for example, holds large amounts of euros and is not expected to need to use them for a year. If the spot EUR/USD exchange rate is 1.3 and the futures price is 1.28 after 12 months, merchant A can choose to sell on the spot market and buy the euro after 12 months at 1.28 to carry out forward arbitrage. For another example, merchant B holds a large amount of corn because of the harvest. Since the crops cannot be stored for a long time, he can sell them on the spot market. However, in order to ensure future supply, he can also buy the corn to be delivered several months in the future in the futures market. 

 

Because spot price and futures price belong to two different markets, so in essence, spot price and futures price also have certain differences. 

 

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Risk Warning: The above content is for reference only and does not represent ZFX’s position. ZFX does not assume any form of loss caused by any trading operations conducted by this article. Please be firm in your thinking and do the corresponding risk control. 

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