A spot vs. futures strategy involves trading in two different markets—spot markets (or cash markets) and futures markets—which have distinct characteristics. Let’s break them down in detail so you can get a sense of how to use each one for different trading or investment goals.
1. Spot Market Strategy
The spot market is where financial instruments like currencies, commodities, or securities are bought and sold for immediate delivery. The price in the spot market is known as the spot price, which is the current market price for the asset.
Key Features:
Immediate Settlement: Transactions in the spot market are settled immediately or within a couple of days, typically 2 business days.
Ownership Transfer: When you buy an asset, you own it right away, and you can sell or use it immediately.
Market Sentiment: Spot prices are influenced by supply and demand factors in the current market.
Strategy:
Short-Term Trading: Spot market strategies often focus on taking advantage of short-term price movements. Traders may buy an asset when they believe its price will rise in the near term, and sell when they expect a price drop.
Hedging: If you hold a physical commodity or asset, you can use the spot market to lock in current prices.
Arbitrage: Exploiting price differences between the spot market and other markets (like futures).
2. Futures Market Strategy
The futures market is where contracts are traded that obligate the buyer to purchase, and the seller to deliver, an asset at a predetermined price on a specific future date.
Key Features:
Leverage: Futures contracts often allow traders to control large amounts of an asset with relatively small initial margin requirements.
Settlement Date: The contract specifies a future date for delivery, which means that you’re agreeing to buy or sell at a set price at a later time.
Risk Management: Futures contracts are used by investors to hedge against price fluctuations, especially in commodities, currencies, or stocks.
Strategy:
Speculation: Traders buy or sell futures contracts to profit from anticipated price movements in the future. If you think an asset’s price will rise, you go long (buy) the futures; if you think it will fall, you go short (sell).
Hedging: Many producers or large consumers of commodities use futures to lock in prices. For example, an airline might use fuel futures to lock in oil prices.
Arbitrage: Like in spot markets, traders can also exploit differences in pricing between spot and futures markets. This is done by buying an asset in one market (spot) and selling it in another (futures), making profit on the price difference.