Understanding The Difference Between Spot & Futures Markets

A commodity spot market is often termed as physical market because there is an exchange of physical asset or good. Spot markets are also known as cash markets. Wholesale and retail markets come under the category of spot markets. In a spot market, goods are sold for cash followed by immediate delivery and price settlement takes place on the spot & price determination is based on pure demand and supply forces.

All APMC mandis are examples of spot market. In a spot transaction, all the process i.e. trading, clearing and settlement occur at the same instant, or almost immediately. For example a turmeric trader wants to buy 1 quintal of the commodity and another trader or a seller quotes Rs.8400 per quintal. They agree upon this price and the turmeric buyer pays Rs 8400, and with this transaction the spot trade is complete.   

A futures market on the other hand is a derivative of spot market and in simple sense, a futures market is the reflection of the spot market in near future. Futures prices are guided by movements in spot prices. Futures markets are highly uniform and well-specified commitments for a particular good. They are delivered at a certain time and place and in a specified manner, with specified quality parameters. Futures price is calculated by adding the spot price with the cost of carry, which includes interest rate, cost of transport, warehousing etc. In other words, a futures price indicates what will be the likely spot price in a future time period.

For example, suppose the spot price of soybean is Rs 7100/qtl, while August and September futures are trading at Rs 7175/qtl and Rs 7250/qtl respectively. This would imply that as per current fundamental market situation, the average spot prices of soybean can remain higher by Rs 75/qtl and Rs 150/qtl during the months of August and September respectively (taking cost of carry in consideration as well).  

Examples of futures markets: India has two leading commodity exchanges namely, Multi Commodity Exchange (MCX), and National Commodity and Derivatives Exchange (NCDEX). Futures trading in India occur mainly through commodity exchanges where trading is carried in standardized contracts, i.e. the lot size, price ticks, the daily price range and quantity is specified by the exchanges. Futures contracts differ from forward contracts in the sense that they are standardized and exchange traded.  

Difference between spot and futures trading will be clear with the help of tabular representation given below:   

For further understanding on commodities or commodity derivatives/futures trading, continue browsing the Agripedia/Commodity sections