| Updated: October 23, 2025Trading Derivative Instruments I
This lesson will cover the following
- Spot market
- Futures market and futures as instruments
- Rollover day
Spot and futures markets
In the previous sections we have talked about trading in the financial markets and have generally described what forces move prices up and down. We also spoke about the foreign exchange market, its major participants and the system as a whole, explaining the chain from retail users at the bottom to liquidity providers at the top. However, we have not yet mentioned that, according to their point of settlement, markets can be categorised as either spot or futures markets.
Spot market
The spot market, also known as the “cash market” or “physical market”, is a financial market on which commodities or financial instruments are sold for cash and delivered immediately. The spot market can be an organised market, an exchange or over-the-counter.
The physical market is the opposite of the futures market, where settlement and delivery are due at a later date. Contracts bought and sold on the cash market become effective instantly, and delivery should be made within two business days of the order being placed.
Participants in the spot market use it to purchase or sell goods physically, which means that many of the players are farmers or producers who need to restock their inventories. Investors who wish to acquire shares in a company also purchase them through the spot market. For example, if you would like to buy Company XYZ shares and own them immediately, you would go to the New York Stock Exchange, or another exchange if the company is listed there. If not, the corporation’s shares would be traded over-the-counter and you can still buy them for cash. If you’d like to purchase gold in the spot market, you could go to a coin dealer and exchange cash for gold.
- Trade Forex
- Trade Crypto
- Trade Stocks
- Regulation: NFA
- Leverage: Day Margin
- Min Deposit: $100
In Forex, the spot market has an imposed two-day delivery period, which originates from the time it once took to transfer money from one bank to another. Most speculative Forex trading is executed as spot transactions on online trading platforms provided by different brokers, something we have mentioned earlier in this chapter.
Futures market
The futures market, on the other hand, is a centralised financial exchange where standardised futures contracts are traded. Under these contracts, a specified amount of a commodity or other instrument must be delivered at a particular time in the future.
Futures are categorised as “derivatives”, instruments based on an underlying asset whose price movement depends, though not solely, on the pricing of the underlying stock, commodity, currency pair, index, etc.
When we speak about such contracts, the key word is standardised. Futures are agreements between two counterparties to buy or sell a standardised quantity of a specific asset of standardised quality at a particular price set today. Delivery and payment occur on a specified future date, also called the delivery date.
Key difference
There is one more key difference between operating in the futures market and participating in the cash market: by holding a futures contract you are not necessarily obliged to receive or deliver large stockpiles of commodities such as gold, oil, copper or corn. Traders enter the futures market primarily to speculate on whether prices will rise or fall, or to hedge risk, rather than to exchange raw materials physically, which is the main purpose of the spot market.
That said, we can conclude that a futures contract is more like a financial position and, unlike the actual farmers or producers who trade in the spot market, most players in the futures market are speculators whose sole goal is to profit from price fluctuations.
Futures have become a major part of the financial markets precisely because neither the buyer nor the seller is obliged to receive or deliver the commodities or securities traded. This raises the following question: since the two counterparties have struck a deal with a maturity date, what happens on that date, and if we don’t want to receive or send a physical shipment, how do we avoid it?
As futures contracts approach maturity, their prices narrow the gap to the spot price of the underlying asset and become equal on the expiry date, a situation known as convergence. It is therefore very important that traders close their open positions to avoid taking delivery of the traded asset. In most cases, the expiry date falls on the third Friday of each quarter—December, March, June and September. A week earlier, the second Thursday of each quarter is known as “rollover” day.
Rollover day
On the rollover day, the trading volume of an expiring futures contract begins to migrate to the new contract month. All market participants who wish to continue holding positions in this asset must therefore exit the expiring contract and enter the next, or “front-month”, contract. Bear in mind that this operation is not executed automatically by the broker; traders must know when that date arrives and then close, or cover, the expiring contract and open a position in the front month.
>The significance of this period lies in the fact that from the rollover day onwards, volume in the expiring contract gradually dissipates until the expiry date the following Friday, which means that liquidity during that last week becomes a major problem. Also, each front month carries a “premium” or “discount” to the spot price of the underlying asset, so the price of the new month will differ from that of the expiring contract.
Apart from the characteristics already noted, there are a few others that further distinguish futures from forward contracts, which we will discuss a little later.
As we said, futures are contracts under which a certain amount of an asset must be traded on a specific date at a price agreed upon today. They are standardised and traded on exchanges and, as such, the interests of each counterparty must be protected. This happens through the so-called initial margin and maintenance margin that an investor is required to deposit and sustain—unlike when trading forwards.
Margin
The initial margin is a good-faith deposit that a trader must place in their account to enter the market. It is used to debit any day-to-day losses. This leads us to another feature of futures contracts: they are settled on a daily basis, which means that at the end of each trading session, your account is debited or credited with your day-to-day losses or gains. Unlike futures, forward contracts are settled only on the maturity date, so daily price movements of the underlying asset have no immediate impact on your account.
When you place an order on a futures contract, the exchange will require a minimum amount of money— the initial margin— which is usually between 5% and 10% of the contract’s value. When you exit your position, you will be refunded the initial margin plus or minus any gains or losses you have accumulated while holding the contract.
After a trader makes their initial deposit and enters a position, they must then maintain what is called the “maintenance margin”, the lowest amount of money that can remain in the account before additional funds are required. If your maintenance margin falls below a certain level after a losing streak, brokers will require you to deposit additional funds to restore the margin to the minimum maintenance level. This is the so-called “margin call”. It is a safety mechanism that clearing houses use to remove the risk of one of the counterparties failing to meet its obligations, thus creating a safer environment for all parties.