Comparison Between Futures Trading and Cash Trading

Most businesses and speculators buy and sell commodities in the cash market, also known as the spot market, since the full price is paid “on the spot.” They use current events and current prices to project where prices may be in the future.

The futures market was created for those who use commodities in their businesses. These businesses that produce or use commodities and routinely buy / sell in the cash market, enter the futures market to protect themselves against risks from volatile market prices. The futures contract is, in effect, an insurance policy against price changes.

There are two types of traders in the futures market:

  1. Hedgers, who use commodities as producers (e.g. farmers, mining companies. oil producers) or as users (bankers, jewelers, oil distributors).
  2. Speculators who have no use of commodities but only trade for profit.

Whereas hedgers initially formed the core of the futures market, speculators are now the majority of the market makers, giving the market liquidity and activity.

Fundamentally, futures are different from spot for the following reasons:

  1. Physical Delivery

    1. Futures: The commodities traded upon can be physically taken possession of
    2. Spot: Spot Foreign exchange contracts are non-physically deliverable but are confirmed and maintained on payment of the margin balance.
  2. Expiration Date

    1. Futures: One day before the end of the contract month, all contracts must be settled. At this stage, a contract can be rolled over into the following month, but only manually (assuming sufficient margin to trade).
    2. Spot: Has an indefinite life span (assuming sufficient margin to trade) and can be rolled over daily for an indefinite period.
  3. Carrying Costs

    1. Futures: Also known as contango, this is a charge incurred at the start of the futures contract for the accommodation of physical delivery when the contract expires.  The charge is variable depending upon the term (period) of the contract.  A commission per contract is usually charged at the end of the contract term.
    2. Spot: Charges only a single round-turn commission regardless of term (period).
  4. Liquidity

    1. Futures: Trading is restricted to specific exchanges and therefore, the number of participants. Futures contracts can only be traded if there is a taker ( a buyer for a sell or a seller for a buy contract). During major market movements, a buyer or a seller could be stuck in a position without recourse because there are no available takers for their contracts.
    2. Spot: Real time transactions occur on a global basis with an exceptionally huge trading volume which ensures execution of trades at any given tme.
  5. Price Limits

    1. Futures: Many exchanges impose a “limit” move on contracts’ maximum price movements (up or down) in a trading day. This results in locked limits, where buyers and sellers cannot exit from their market positions because their entry price has been locked out due to a major movement of the price limits.
    2. on the Spot: Has no such price-limiting structure.
  6. Trading Period

    1. Futures: Limited to the hours of the exchange that contracts are being traded on, which is usually seven or eight hours.
    2. on the Spot: Buy/sell currencies twenty-four hours through all banking centers in the world non-stop. This greatly adds to the participation and activity of the market, and hence, its enormous liquidity.
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