What is the difference between the cash and futures market?
In the Contract for Difference market, you may sometimes notice that the contracts are described as relating either to cash or rolling futures. So, what’s the difference, and does it matter to your trading?
New or existing traders who want to trade CFDs online need to have a good grasp of these two concepts and learn to compare cash vs futures. Let's jump right in and find out what is the difference between the cash market and the futures market.
What is the cash market?
A cash market - also known as a spot market or physical market - is a market where a financial instrument is traded for immediate delivery. The spot price - or cash price - for a commodity is the current quote for immediate purchase, payment, and delivery of that commodity. The trading of the commodity is done "on the spot".
What is the futures market?
A futures contract is a contract between two parties in which one party agrees to buy a certain quantity of a commodity or financial instrument at an agreed price with a pre-determined delivery date in the future.
A number of assets are more commonly priced in the futures market and oil is a great example of this. A whole raft of variables come into play here, from the grade or quality of the oil to the location of delivery, but there’s also a date when the goods are delivered and the financial liabilities are settled between buyer and seller – that’s the point at which the contract expires.
What is the difference between the cash market and the futures market?
Cash markets can operate on a regulated exchange or OTC (over-the-counter). OTC markets often operate 24/5 and allow more flexibility. Meanwhile, futures trading occurs on regulated exchanges.
Another key difference is the settlement date. Cash trades often get settled 2-3 days after the transaction date, while futures contracts have a pre-determined delivery date in the future that could for example be in 1, 2, or 3 months.
When trading CFDs, the main difference is the cost of holding the position overnight. Futures CFDs do not have any overnight swap charges but are subject to rollover charges when the underlying asset is due for expiry. With cash CFDs, there are no contract rollovers, but an overnight swap fee will be charged.
Short-term traders will generally prefer cash vs futures due to the lower spreads, while long-term traders may opt for futures CFDs instead, as they are less sensitive to the spread, but prefer not to pay daily swap charges.
Example of a cash CFD trade
Since there is no rollover involved, trading cash CFDs is similar to trading currency pairs.
Example:
Trader A determines that the price of oil is likely to increase against the US Dollar in the short term, so the trader enters a long (buy) position.
Trader A opens their cash CFD trade when the price of USOIL is at $80 per barrel and the price of the commodity subsequently rallies (increases) to $81 per barrel. Since Trader A was speculating on an intraday increase, he decided to close his position at a profit and as the position was not held overnight, no swap fee was charged.
Example of a futures CFD trade
Futures contracts are based on the relevant futures exchange price. Futures contracts expire because they are related to a definitive date. There are many months traded and the forward prices can be higher or lower depending on market conditions.
In order to remove final day volatility, brokers switch from using the front month contract to the second month’s contract one trading day prior to the exchange expiry.
An example of this is when the Australian SPI contract for March expires. The June price needs to be used and the price on the MT4 platform may increase or decrease depending on the value of the June contract relative to the March contract. This is obviously not a price rise or fall in the SPI but just a move to a new reference price, therefore no profit or loss will be incurred as a result.
In order to ensure this does not affect clients, a cash adjustment needs to be made by brokers. This is explained in the following examples.
Example:
SPI March closes at 5050/5051 and SPI June opens at 5000/5001
Your position: 10 buy contracts
If your position is a buy, it closes on the old bid price of 5050 and reopens on the new ask price of 5001.
Because you are in a buy and the new market price has decreased, your open trade P&L has made a loss. As a result, you will receive a positive adjustment amount in your swap column equal to the difference between the old bid and the new ask.
You will receive (5050-5001)*10 contracts = $490AUD
Example:
Your position: 10 sell contracts
If your position is a sell, it closes on the old ask price of 5051 and reopens on the new bid price of 5000.
Because you are in a sell and the new market price has decreased, your open trade P&L has made a gain. As a result, you will receive a negative adjustment amount in your swap column equal to the difference between the old ask and the new bid.
You will receive (5051-5000)*10 contracts = -$510AUD
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This information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. It has been prepared without taking your objectives, financial situation, or needs into account. Any references to past performance and forecasts are not reliable indicators of future results. Axi makes no representation and assumes no liability regarding the accuracy and completeness of the content in this publication. Readers should seek their own advice.
