The difference between spot and futures in forex

Before a description of retail trading, it is important to understand the difference between the spot and futures markets. Futures are generally based on contracts, with typical durations of 3 months. Spot, on the other hand, is a two-day cash delivery. While the futures markets were created to hedge out risks and speculate on future market conditions, spot was created to allow actual cash deliveries. Spot developed a two-day delivery date to give those transporting the actual cash a window of time to receive it. While in theory there still is a two-day delivery date imposed after a forex transaction, this is effectively no longer used. Every day, at 5 pm EST (the predetermined end of the trading day) spot positions are closed and then reopened. This is done to guarantee an unlimited timeline for delivery. For example, if a spot transaction occurs on a Monday, the delivery date is Wednesday. At 5 pm on Monday, the position is closed and then immediately re-opened; now this is a new position with the close date of Thursday. This daily process allows an investor to hold open a position indefinitely.

Another important difference between futures and spot is how interest is credited. Each currency in a forex transaction has an inherent interest rate attached to it. In the case of the US dollar, this is the Federal Funds Rate. This interest is added every day whether the market is trading or not. Interest cannot take a vacation; money and its loaning value are still important even if the financial world has stopped dealing. In futures, the interest is built into the price of the contract. In spot, however, interest is not taken into account in the offering price because the spot market is a cash market, not a contract market. There must be some mechanism for crediting interest, and various institutions have developed ways to do it. The most common method is to credit that day’s worth of interest at the same time they “flip” the position, or carry it over to the next day. This is important for later discussions and analysis because the transactions examined in this study had interest credited at the end of the business day at exactly 5 pm EST. If a position was held from 5:01 pm on Tuesday and closed at 4:59 pm on Wednesday, no interest would be credited for that day. If, on the other hand, a position was opened Tuesday at 4:59 pm and closed Tuesday 5:01 pm, a full day’s interest would be credited. This has interesting ramifications; traders who work intra-day, or “day traders,” often do not use interest for either gain or loss.