The Commercial Markets
Cash Market and Future Market are both commercial markets. The cash market is for on-spot payment while in the case of future market payment is done after a time span in the future. Both are important in the share market. The cash market and the futures market are veiled by the buyers and sellers of shares according to their preferences. While specific companies also might keep their shares on the basis of either of these two.
We will learn what the cash market is and what the future market is, also we will illustrate the difference between these two markets.
Cash Market Meaning
The cash market is the marketplace in which financial tools like commodities and securities are being purchased and are received in the exchange for cash, these cash markets are also known as spot markets as the transactions are settled on the spot.
Cash market transactions can also be conducted either in a regulated environment like in a stock exchange or in some other environment like over-the-counter transactions which are deemed as unregulated environments.
What is a Cash Market?
Cash market means – the marketplace where the commodities, securities are being paid for and these are received at the point of sale. For example - in the stock exchange – the prevailing cash market is a general scenario here as the investors receive the shares immediately in exchange for cash.
Cash markets are called spot markets because their transactions get settled "on the spot." This is in contrast with futures markets, where the buyers pay for the right to receive the goods, such as a barrel of oil, at a specified date somewhere in the future.
Note: Students should not confuse the cash market with the money market. The money market involves trading of the cash equivalents (they are very short-term debt instruments) like Treasuries and commercial paper.
Example of a Good Cash Market
‘Ajmer Ltd.’ is a manufacturing company that uses wheat in several of its food items. Rather than cultivating the wheat directly, Ajmer relies on the cash market in order to provide their wheat supplies. It purchases a good amount of wheat each month from the farmers, in return for which the company pays them in cash and they also stockpile their products in their warehouses.
Ajmer also uses the forward contracts to secure the right to purchase the wheat at a predetermined price in the future times. In these cases, Ajmer does not take possession of the wheat during the point of sale. These transactions take place on an OTC (over-the-counter) basis between Ajmer Ltd and another specific dealer or food broker.
Future Market Meaning
Future Market is basically a commercial marketplace where future agreements are being purchased and sold. The word ‘futures contract’ means an agreement that is performed in the prospect.
This is an agreement between two different parties in which one party gives his or her consent for the purchase of a particular amount of a good or financial tool at the consented cost price and at the shipment price of the material. This is done at a succeeding date (pre-specified) in prospect.
What Is a Future Market?
A futures market is the auction market where the participants which include the buyer and the seller buys and sells the commodity and all the future contracts for the delivery on a specified future date. Futures are the exchange-traded derivatives with contracts that are locked up in the future for delivery of the commodity is secured at a price that is set today.
Examples of futures markets are - New York Mercantile Exchange (NYMEX), the Kansas City Board of Trade, the Chicago Board of Trade (CBoT), Chicago Board Options Exchange (CBOE), the Chicago Mercantile Exchange (CME), and the Minneapolis Grain Exchange.
Originally, trading is carried through open outcry and the use of hand signals in the trading pits which is located in the financial hubs like in New York, Chicago, and in London. In this 21st century, like most other markets, even futures exchanges have become primarily in electronic mode.
Future Market Example
A coffee farm sells black coffee beans at 12 per pound and thus both are making a profit at that stipulated price, they will probably want to keep these costs at a fixed rate. The investor agrees to this - if the price for coffee goes below the fixed or set rate, the investor will agree to pay the difference to the coffee farmer.
If the price of the coffee goes higher than at this certain price, the investor will get to keep the profits. For the roaster, the price of the green coffee goes above the agreed rate, the investor will pay the difference and the roaster will get the coffee at the determined or predictable rate. If the price of green coffee becomes lower than the agreed-upon rate, then the roaster will pay the same price to the investor and thereby the investor will get the profit.
The difference table – Cash Market Vs Future Market
Point of Difference | Cash Market | Future Market |
Define | The cash market is referred to as the marketplace where financial tools like commodities and securities are being purchased and are received in exchange for goods and services. | Future Market is the commercial marketplace where the future agreements are purchased and sold in that particular marketplace. |
What is the need for the purpose? | In order to buy the trades and shares in the market. | For speculations and for hedging activities. |
Ownership of these shares | When anyone will hold the shares then he/she is regarded as the shareholder. | No option to become a shareholder. |
Delivery | Delivered on T+2 days | No delivery will take place. The future contract expires on the expiration date. |
Payment | The full amount is to be paid during the time of payment. | Only the margin money is required to be paid in future contracts. |
Lot size | You can buy a single share of the company. | One must buy a minimum lot of size which is already defined. |
Holding period of shares | In the cash market, you can hold the shares for a lifetime after buying them. | In the future market, you need to settle the contract on the expiration date (maximum time is three months) |
FAQs on Cash Market Vs Future Market
1. What is the main difference between the cash market and the futures market?
The main difference lies in the settlement of transactions. In the cash market (also called the spot market), the purchase and sale of securities or commodities are settled almost immediately, with ownership and payment transferred 'on the spot' (e.g., within a T+1 settlement cycle). In the futures market, participants trade contracts to buy or sell an asset at a predetermined price on a specified future date, without an immediate exchange of the asset.
2. How does a transaction in the cash market work with an example?
A cash market transaction involves the immediate payment and delivery of a financial instrument. For example, if you buy 10 shares of a company in the stock market's cash segment at ₹200 per share, you pay the full amount of ₹2,000 (plus brokerage) and receive the shares in your demat account almost instantly, as per the T+1 settlement cycle. You become a direct owner of those shares right away.
3. What is the purpose of the futures market if you don't get immediate ownership?
The futures market serves two primary purposes that don't require immediate ownership:
- Hedging: It allows businesses and producers to lock in a future price and protect themselves against potential price fluctuations. For instance, a farmer can sell a wheat futures contract to guarantee a certain price for their crop at harvest time, regardless of market volatility.
- Speculation: Traders can speculate on the future price direction of an asset. They aim to profit from the price difference between when they enter the contract and when they exit, without ever needing to own the underlying asset.
4. What is the relationship between the cash market and the derivative market?
The relationship is fundamental: the value of a derivative is derived from an underlying asset that is traded in the cash market. The futures market is a major part of the broader derivative market. For example, the price of a gold futures contract is directly influenced by the current (spot) price of gold in the cash market, along with expectations of its future price, interest rates, and storage costs.
5. Why is the future price of a commodity often different from its current cash price?
A future price can differ from the cash (spot) price due to the 'cost of carry' and market sentiment. This leads to two main scenarios:
- Contango: When the futures price is higher than the spot price. This typically happens when costs like storage, insurance, and financing for holding the asset until the future date are factored in.
- Backwardation: When the futures price is lower than the spot price. This can occur if there is a high immediate demand or a current shortage of the commodity in the cash market, making it more valuable right now than in the future.
6. How does the cash market differ from the F&O (Futures & Options) segment?
The cash market and the F&O segment are different parts of the stock market. The cash market involves buying and selling actual shares for immediate delivery and full payment. In contrast, the F&O segment deals with derivatives like Futures and Options. In this segment, you trade contracts based on an underlying stock or index, operate on margin (a fraction of the total value), and involve a high degree of leverage, which magnifies both potential profits and losses.
7. Is trading in the futures market riskier than in the cash market for a student investor?
Yes, for a student or new investor, the futures market is generally considered much riskier than the cash market. The primary reason is leverage. In the cash market, your maximum loss is the capital you invested. In the futures market, because you only pay a small margin to control a large contract value, a small adverse price movement can lead to losses that can exceed your initial margin, making it a high-risk, high-reward environment suited for experienced traders.
