A market of commodities or securities in which goods are sold for ready cash and delivered immediately is known as Spot Market. Spot market is real time market for instant sale of commodities like grain, gold and other precious metals, Ram chips etc. It is a spot market because transactions take place on the spot. For example merchants and traders go to the fields and buy the standing crop or the freshly reaped crop at the spot. Since cash changes hands it is also called a Cash Market and since stock is physically delivered it is also called physical market.
Nature: The contract entered in the spot market becomes immediately effective. Prices are settled at current prices. The primary activities of buying and selling are carried out in spot market. A spot market can operate only where necessary infrastructure is available. For example securities can be traded and money can be transferred through internet. Thus internet provides a spot market for securities. Grains, cotton and other agricultural commodities are traded at the farms.
Spot Forex: For a foreign exchange transaction it takes two days for cash movement through bank channels across the countries. Even so it can be called a spot market because two days is the minimum required time to clear money transfers.
Energy Spot Market: Producers of surplus energy find buyers, negotiate the price and deliver the energy within minutes. This market can be controlled by government agencies, private operators or industry organizations.
Spot Market and Farmers: While spot market provides a ready market for the farm produce which reduces the farmer’s cost on transportation and warehousing, not to speak of the legal hurdles that the farmer has to face in commodity movement, there is a wide gap between the farm gate price and consumer price. The traders enjoy monopoly and there is less transparency in pricing. Unless the farmer has complete knowledge about the prevailing price, he would be put to insufferable loss.
To avoid such difficulties, NAFED and other cooperative organizations stepped in to help the farmer procure reasonable price in the spot market. They are successful in integrating the fragmented market and equating small producers and farmers with large consumers and traders. They also succeeded in reducing the number of intermediaries involved in the process of trade.
As opposed to spot markets, deals are stuck for future action in the future markets. A future contract can be defined as a type of financial contract wherein parties agree to exchange financial instruments like securities or physical commodities for future delivery at a particular price. Future contract is a standardized contract to buy at a future date at a certain price.
Nature: Commodities in the future market can be reasonably expected to be delivered within a month or so. Future market is not a ready market like a spot market. Future market does not involve primary activity and it is speculative in nature. In the future market, deals are stuck at forward prices. A future contract gives the holder the obligation to buy or sell. Both parties to the contract must fulfill the contract. Here everything is in a fluid state until the security or commodity reaches the buyer’s hands and the consideration reaches the other party.
The future date is called delivery date and a final settlement date. The pre set price is called futures price. The price of the underlying asset on the delivery date is called the settlement price. Future traders are traditionally two groups- hedgers who have an interest in the commodity being traded like farmers, producers and consumers and speculators who seek to make profit by predicting market moves. There are many kinds of future contracts like Foreign Exchange market, Money market, Bond market Equity index etc.
Risks involved: Future market is full of risk because anything might go wrong at any stage and the transaction may become invalid or void. Stock markets all over the world are highly volatile and the value of the traded security may go down at any time. Similarly if a commodity like crude oil is traded, the happening of the future event may be subject to political equations between the two countries; unrest in a neighboring country may delay the delivery. Thus the future market does not meet the safety requirement of business. Trading in future market is not for the risk averse. It is only for those who trust others and their own luck. A very small percentage of future contracts turn to physical delivery.
There is no standardization and gradation which makes it impossible for certification. There is also no authentic price for making DDR calculation.
As far as the futures market in farm produce is concerned, the farmer has a guarantee for payment and quality risk is avoided. It promotes storage and warehousing facilities and logistics facilities. It also increases the bargaining power of the farmers and enables decision on crop sowing and time of sale.