What is a spot contract?
Spot contracts are used in most transactions where the settlement price is known at the exact moment an order is placed – whether that’s property, money or financial assets. Discover how spot contracts work and how to trade them.
What is a spot contract?
A spot contract is an agreement that enables you to buy and sell an asset at the current market rate, known as the spot price. Spot contracts are most commonly associated with commodities, currencies and bonds, but are also available on a range of markets, such as cryptocurrencies and even property.
Most spot contracts are settled physically, resulting in the delivery of the asset in question, which usually takes place within one business day. However, forex trades can take approximately two days. For example, if you bought a spot contract on Brent crude oil, you’d pay the most recent market price and take ownership of the underlying oil but delivery would occur the next day.
In most instances, you’d pay at the point of purchase rather than settlement – in what’s known as a ‘buy now, pay now’ arrangement. This is in contrast with futures, forwards and options, which are all used to speculate on the future value of a market. For all three contracts, you’d agree the price of an asset in the present, but set a date of exchange at some point in the future – known as the expiry date.
When you trade spot contracts with us, you’d be speculating on the underlying market price. This means you’d never have to take physical delivery of the asset in question and would always settle in cash. You’d be taking a position on whether spot prices will rise or fall, which would open up a wider range of opportunities.
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How do spot contracts work?
Spot contracts work by tracking the spot price of an asset, so that you can take a position on the most recent buy and sell orders of market participants.
Once you’ve chosen a price level you’re comfortable entering the market at, you can enter your position. At which point, your spot contract is automatically created, and you’d be part of a binding agreement to exchange the asset immediately or settle in cash.
Spot prices usually change much faster than futures or options markets, especially in liquid markets where there are a high number of market participants making bids and offers. Fast-changing rates can impact your trade, as it could be executed at a different price from the one you requested – known as negative slippage.
To prevent slippage, you can attach a guaranteed stop loss to your position, which will ensure your trade is always placed at the level you’ve chosen. There is no fee to attach the stop, but if it is triggered, you would incur a small premium.
How can you trade on the spot?
You can trade spot prices by:
- Creating an account and logging in
- Searching for the market you’d like to trade – eg ‘gold’
- Selecting ‘spot’ at the top of the deal ticket in the right-hand panel
- Decide whether to ‘buy’ or ‘sell’ the spot market
- Choosing your trade size and opening your first position
Alternatively, you could practise trading spot contracts in a risk-free environment first, by creating a demo account.
When you trade spot contracts with us, you’ll be using CFDs to speculate on the underlying market price of the asset, rather than entering into a spot contract yourself. This means you’d never physically settle the exchange.
Our proprietary ‘spot’ prices are based on the two nearest futures on the market in question. They reflect the underlying market but with no fixed expiries, making them suitable for both beginners and experienced traders. Spot prices are available on all of our currency, commodity and cryptocurrency markets, as well as our German Bund government bond market.
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As CFDs are derivative products, you can take advantage of markets that are falling in price, as well as those that are rising – opening up a wider range of opportunities.
Both products are also leveraged, meaning you can get full market exposure for just a small initial deposit, called margin. While leverage can magnify your profits, it can also magnify your losses. This makes it important to have a risk management strategy in place.
Example of a spot contract
Gold is trading at $1400. You want to buy and take ownership of the precious metal immediately, so enter a spot contract at the current market price. You would pay $1400 for the position, and receive delivery the next day – unless you decided to settle in cash.
Working example of a spot contract
If you wanted to speculate on spot contracts instead, you would be speculating on the underlying price rising or falling.
Say you believe the price of gold is going to rise from its current price of $1400 per ounce. So, you open on the spot price, which would profit if it increases. You opt to buy the market for £30 per point of movement at the current price of 1400.30 – you’d be buying slightly above the underlying market due to the spread.
As gold has a margin factor of 5%, you’d pay £2100.45 (£30 x 1400.30 x 5%) to open a position.
The price of gold did increase up to a new price of 1450. So, you decide to reverse your trade and ‘close’ your position at the new sell price of 1449.7 – slightly below the market price due to the closing spread. The market moved in your favour by 49.4 points, so you’d be taking a profit of £1482 (49.4 x £30) – excluding any other costs.
However, if gold had decreased in price instead, to down to 1380, you would have made a loss. Closing your position at the new sell price of 1379.7, you’d have lost £618 (20.6 x £30) – plus any funding charges.
Spot contracts summed up
- A spot contract is an agreement to exchange an asset at the current market rate – known as the spot price
- Spot contacts are associated with commodities, currencies and bonds, but are also available on a range of markets, such as cryptocurrencies and property
- You can settle spot contracts physically or in cash
- The settlement period for spot contracts is between one and two business days
- Spot contracts track the underlying price of an asset, enabling you to take a position on the most recent buy and sell prices from market participants
- Once you’ve chosen a price to trade at, you’d automatically be entered into a spot contract and be obliged to settle the exchange
- Spot prices can change rapidly due to the high volume of traders, so it’s important to be aware of the risks of slippage and mitigate them with guaranteed stops
- You can trade spot contracts via CFDs to take advantage of rising and falling prices
This information has been prepared by IG, a trading name of IG Australia Pty Ltd. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients.
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