A crucial factor in deciding the price of a futures contract is the spot price. It can reveal forecasts for future commodity price variations.
Spot Price vs. Future Price
The primary distinction between spot and futures prices is that spot prices are for immediate purchase and sale, but futures contracts postpone payment and delivery to predetermined future periods.
Typically, the spot price is lower than the futures price. Contango is the term for this circumstance. Contango is a regular occurrence for non-perishable items with high storage costs.
Backwardation, on the other hand, occurs when the spot price is higher than the futures price.
The futures price is expected to eventually converge with the current market price in either case.
More Resources
Thank you for taking the time to read CFI’s guide to spot prices and the differences between them and futures prices. Check out the following resources to learn more about capital markets and related topics:
Is it better to trade futures or spot?
“Which market is better to trade, spot or futures?” traders sometimes wonder.
If you’re searching for a longer-term investment, the short answer is spot markets. You should trade the futures market if you wish to hedge your trades or boost your leverage.
I hope that’s as plain an answer as you’ll find on the spot market vs. futures market issue anyplace on the internet.
Let’s unpack this topic further now that I’ve addressed the answer for those of you with a 10-second attention span.
What is the difference between spot and futures trading?
Financial products such as commodities, currencies, and securities are traded on the spot market for quick delivery. The exchange of cash for the financial instrument is known as delivery. A futures contract, on the other hand, is dependent on the underlying asset being delivered at a later time.
Why are futures preferable to spot?
An outline of the differences between spot and futures trading They don’t have an expiration date. The spreads on futures markets (also known as forwards markets) are wider, but there are no overnight costs. They have a specified expiration date in the future. Day traders will find spot markets more appealing, while longer-term traders will find futures markets more appealing.
Is spot trading profitable?
A spot market is a financial market where you can buy and sell assets at spot prices that are based on the price of the underlying item. Spot trades have no fixed expiries and allow you to open short-term positions, making them popular among day traders. You will trade the spot market using CFDs with us, which means you will not have to accept possession or delivery of the assets.
What is the process of spot trading?
Investors engage in spot trading when they buy an asset at its current market price and receive payment and delivery of that security right away. These transactions take place on over-the-counter (OTC) marketplaces as well as major stock exchanges like the New York Stock Exchange (NYSE) and the Nasdaq Stock Market.
What are the ways futures traders make money?
The value of futures and options is determined by the underlying, which might be a stock, index, bond, or commodity. For the time being, let’s concentrate on stock and index futures and options. The value of a stock future/option is derived from a stock such as RIL or Tata Steel. The value of an index future/option is derived from an underlying index such as the Nifty or the Bank Nifty. F&O volumes in India have increased dramatically in recent years, accounting for 90 percent of total volumes in the industry.
F&O, on the other hand, has its own set of myths and fallacies. Most novice traders consider F&O to be a less expensive way to trade stocks. Legendary investors like Warren Buffett, on the other hand, have referred to derivatives as “weapons of mass destruction.” The truth, of course, lies somewhere in the middle. It is feasible to benefit from online F&O trading if you master the fundamentals.
1. Use F&O as a hedge rather than a trade.
This is the fundamental principle of futures and options trading. F&O is a margin business, which is one of the reasons retail investors get excited about it. For example, you can buy Nifty worth Rs.10 lakhs for just Rs.3 lakhs if you pay a margin of Rs.3 lakhs. This allows you to double your money by three. However, this is a slightly risky approach to employ because, just as gains can expand, losses in futures might as well. You’ll also need enough cash to cover mark-to-market (MTM) margins if the market moves against you.
To hedge, take a closer look at futures and options. Let’s take a closer look at this. If you bought Reliance at Rs.1100 and the CMP is Rs.1300, you may sell the futures at Rs.1305 and lock in a profit of Rs.205 by selling the futures at Rs.1305 (futures generally price at a premium to spot). Now, regardless of how the price moves, you’ve locked in a profit of Rs.205. Similarly, if you own SBI at Rs.350 and are concerned about a potential fall, you can hedge by purchasing a Rs.340 put option at Rs.2. You are now insured for less than Rs.338. You record profits on the put option if the price of SBI falls to Rs.320, lowering the cost of owning the shares. By getting the philosophy correct, you can make F&O operate effectively!
2. Make sure the trade structure is correct, including strike, premium, expiration, and risk.
Another reason why traders make mistakes with their F&O deals is because the trade is poorly structured. What do we mean when we say a F&O trade is structured?
Check for dividends and see if the cost of carry is beneficial before buying or selling futures.
When it comes to trading futures and options, the expiration date is quite important. You can choose between near-month and far-month expiration dates. While long-term contracts can save you money, they are illiquid and difficult to exit.
In terms of possibilities, which strike should you choose? Options that are deep OTM (out of the money) may appear to be cheap, but they are usually worthless. Deep ITM (in the money) options are similar to futures in that they provide no additional value.
Get a handle on how to value alternatives. Based on the Black and Scholes model, your trading terminal includes an interface to determine if the option is undervalued or overvalued. Make careful you acquire low-cost options and sell high-cost options.
3. Pay attention to trade management, such as stop-loss and profit targets.
The last item to consider is how you handle the trade, which is very important when trading F&O. This is why:
The first step is to put a stop loss in place for all F&O deals. Keep in mind that this is a leveraged enterprise, thus a stop loss is essential. Stop losses should ideally be included into the trade rather than added later. Above all, Online Trading requires strict discipline.
Profit is defined as the amount of money you book in F&O; everything else is just book profits. Try to churn your money quickly since you can make more money in the F&O trading company if you churn your capital more aggressively.
Keep track of the greatest amount of money you’re willing to lose and adjust your strategy accordingly. Never put more money on the table than you can afford to lose. Above all, stay out of markets that are beyond your knowledge.
F&O is a fantastic online trading solution. To be lucrative in F&O, you only need to take care of the three building components.
Why is the futures price lower than the actual price?
If the striking price of a futures contract is lower than the current spot price, it indicates that the present price is too high and that the predicted spot price will fall in the future. Backwardation is the term for this condition.
Is it possible to go short in spot trading?
Short selling has a really ominous undertone. Short selling is usually associated with highly dark and covert dealers attempting to break the stock or market. Short selling is nothing like that in reality. It’s merely a market point of view. You buy the stock when you expect it to rise, and you sell it when you expect it to fall. It’s nothing more than a directional view of the stock. Let’s imagine you own 2000 shares of Tata Motors and expect the stock to fall sharply as a result of JLR’s poor performance. What would you do in this situation? You would obviously sell the stock and wait for a better price to buy it again at a later time. What if you didn’t have the stock on hand? The answer is that you can still short sell the stock even if you don’t have it yet.
However, the most important question is when to short sell a stock. You have two choices in front of you. You can either short sell in the spot market or short sell in the futures market. Here’s a quick rundown of everything you need to know about short selling.
You can sell a stock without owning it in two ways. To begin with, you can short sell in the cash market. You must be aware that you can only short sell intraday in this case. That is, if you sell a stock in the morning but are unable to deliver it, you must cover your position (purchase it back) by the conclusion of the trading day. Keep in mind that Indian markets use T+2 rolling settlements. That is, if you do not square up your holdings on the same day, these stocks will be delivered automatically. If you sell anything in the morning and don’t buy it again by the evening, you must deliver the stock. When short selling in the spot market, keep this key point in mind.
Another choice is to sell the stock as a futures contract. If you do not have delivery of shares in Tata Motors but still wish to sell the stock, you can sell Tata Motors Futures. You are not under any obligation to cover the post by the evening. You can choose from 1-month, 2-month, and 3-month futures. Of course, liquidity is usually limited to the first two months’ contracts, so you may need to roll over your bets. However, because spot and futures prices are so closely related, your reward will be identical to selling the stock when the price falls.
While short selling appears to be a straightforward strategy, selling futures may be a superior option if you have a negative outlook on a stock. Here are five of them.
When selling on the spot market, your selling window is only one day. Price movement, on the other hand, may not occur on the same day, forcing you to close the trade at a loss. Selling futures is a superior alternative in this case.
Short delivery is a danger when selling in the cash market. What exactly do we mean when we say “short delivery”? Assume you sold Tata Motors first thing in the morning. Intraday trading positions are usually closed out by the broker, but you are still responsible. It’s possible that if you forget to close out your short position on the same day, you’ll get a late delivery. Short delivery goes to auction under exchange rules, and the losses can be as high as 10-15%, which you will have to bear.
Selling futures has the advantage of allowing you to sell not only stocks but other indexes such as the Nifty and Bank Nifty. As a result, you can take a long-term view on a sector or the market as a whole and use indices to play this trend. In the spot market, that facility is not available for short selling.
You can use options to hedge your short position. Your call could go awry if you sell futures or spot. So, what exactly do you do? You can use options to hedge your position while selling futures. So, if you’re selling Tata Motors futures, you can protect yourself by purchasing a greater call option. Short selling on the spot market does not allow for this.
When selling futures, you must pay a margin. In reality, whether you’re long or short on futures, the margins are the same. This allows you to take a futures short position while just paying a half margin of roughly 15-20%. This saves you money.
While you have the option of selling on the spot market, it comes with a number of drawbacks. Stock financing has exploded in other nations, making short selling in the spot market a more viable option. Selling futures is a better alternative until that happens in India as well!
