There are different types of market participants in stock markets. Some prefer to receive securities immediately, while others prefer to receive securities at a later date. The instantaneous trade of security occurs at its spot price.
You can get immediate delivery of the respective security, subject to regulation, if you execute the trade at its spot price. There are several factors that influence this price, and we will learn about them as we move ahead.
What Is a Spot Price?
As the name suggests, this value represents the current market price of a security. You can buy or sell securities on the spot, and they will be available for immediate delivery.
Spot price changes throughout the market hours. However, such prices are generally uniform across different financial markets. Because there are no major pricing differences for the same security in multiple financial markets, market participants are unable to take advantage of arbitrage opportunities.
How is the spot rate determined?
. The overall demand and supply sentiments are the primary factors that determine the spot prices of various assets. For example, because of some news if the demand for the dollar rises then the price will also go up.
It is essential for you to check the spot price of different commodities from publicly available and reliable sources.
What Is the Relationship Between Spot Price and Strike Price?
The relationship between spot and strike prices is important in the effective trading of derivative instruments in the financial markets.
In order to understand the relationship between spot and strike prices, let’s discuss the significance of in the money (ITM), at the money (ATM) and on the money (OTM) call options.
- An option contract is said to be in-the-money whenever the strike price of that contract is lower than the spot price of the underlying asset. It imparts a positive intrinsic value to the contract.
- In case of at-the-money option contract, the strike price is equal to the current market price of the underlying security. This indicates zero intrinsic value.Finally, an out-the-money option contract is one whose strike price is higher than spot price of the underlying asset. These types of options do not have any intrinsic value.
Options always have a positive or zero value irrespective of the option being ITM, ATM or OTM.. This is because option premium can be divided into two: Intrinsic value & Time value.
Spot prices remain in constant churning, as they are influenced by a number of factors. It goes a long way in determining strike prices of contracts, as both are correlated.For example, in a call option, spot price is directly correlated to strike price ,i.e., increase in spot price will lead to increase in intrinsic value & vice versa.
Example to Show How Spot Price Works
Let’s consider an example that will provide more clarity about this subject.
Let’s say the stock price of Company ABC is trading at ₹1600 on stock exchanges. If you want to purchase one share, you need to transfer ₹1600 to your broker, and place an order for 1 quantity of ABC. Once the order is matched by the exchange, it will be settled and the broker will transfer the shares to your DEMAT account.
There is another way of buying these shares, i.e., by signing a derivative contract with a seller who has stock of Company ABC. You will be receiving a predetermined number of shares at a predetermined price on or before expiry after executing the contract.
Therefore, we can see that the price paid for security which leads to immediate delivery is the spot price. However, if you enter into a derivative contract the price agreed to be paid for it in the future is referred to as the strike price.
Spot price refers to the prevailing market value of an asset which is available for immediate delivery. The market forces of demand and supply and various economic and non-economic factors influence the spot price of a security.
Frequently Asked Questions
What are the types of spot markets?
A spot market is a publicly traded exchange and is centralised in nature. However, over-the-counter markets are decentralised. In the former, terms of trade are uniform, but for the latter, conditions related to trade depend on the participant’s discretion.
How does spot price indicate market sentiments?
A rising spot price will mean that markets are bullish for the corresponding security. Furthermore, a falling spot price will mean bearish or pessimistic market sentiments.
Is strike price and spot price the same?
No, both are distinct concepts. Strike price refers to the predetermined price at which derivative traders agree to trade their assets on a future date. In contrast, spot price refers to the current market price of an asset and is used as a reference for computing its strike price in a derivative contract.
What is the advantage of trading in spot markets?
One of the most significant advantages of trading in spot markets is that it provides a transparent and conductive trading environment in which information on transactions, company fundamentals, etc., is freely available to all.
Darshan is an up-and-coming Investment analyst making headway in the field of capital markets. He has completed his Chartered Accountancy and CFA Level 1 exam. He is currently working as a Credit Associate in Wint Wealth.