Table of Contents
1 . Spot Contract: What Is It? 2 . Pros and Cons of Using Spot Contracts 3 . How is a Spot Contract Different From Forward Contract?
If you’re new to trading and contracts, congratulations! This guide will serve as the first introductory lesson into spot contracts in trading. What are spot contracts? Why should you know about them? How do they work? We have answered these questions in this guide.
Spot Contract: What Is It?
A spot contract is the basic product of any exchange marketplace available. It refers to the selling or buying of currencies, commodities and derivatives. Spot contracts are used for immediate settlement of an agreement on a spot date. The trade transaction takes place at the current market rate at the time when you’re making the transaction. In most cases, spot contracts are carried out due to the urgency of requirements. Essentially, these contracts are of a “buy now and pay now” nature with immediate delivery. The trade date is the day on which the spot contract is agreed, whereas the settlement date is the day when funds or assets are physically delivered and exchanged.
Pros and Cons of Using Spot Contracts
There are advantages and disadvantages to spot contracts, just like other financial instruments. Whether you opt for spot contracts depends on your requirements and the product in question. Here are the benefits of using spot contracts:
Spot contracts are useful when you need to make payments with extreme urgency. You can deliver the funds or underlying assets to the seller on time.
You also get to secure the transaction at the current market rate and make the payment right away.
That said, spot contracts also have their drawbacks, such as:
The spot market isn’t flexible when it comes to timing. This means parties have to oversee the physical delivery of the asset on the spot.
There is also a risk of counterparty default risk in the spot market.
How is a Spot Contract Different From Forward Contract?
The difference between a spot and a forward contract lies in the manner in which each contract is carried out. For instance, forward contracts allow you to reserve the forward price of a commodity or currency on a future date. This is a “buy now and pay later” type of contract.
Spot contract enables a trader to immediately trade at the current market price. So if the current rate is high, you can benefit from it.
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