What is Spot Pricing Mechanism?

Read to know what is spot pricing mechanism.

While trading commodities mainly gold we might have across terms like sport price. Let us dig a little deeper to understand what sport price is and its mechanism.

What is the spot price?

A spot price is the current price of a security, or asset that can be bought or purchased at a particular place and time. The price holds more importance in the derivative markets since it acts as a based indicator for pricing a futures contract and represents the market expectations of a security’s future price. Moreover, it helps traders/investors to estimate the future price movement of stocks.

To understand spot pricing better, let us look at an example.

Say, we have a shop that sells sugarcane juice. For each glass of sugarcane juice, he charges Rs 15. The juice seller normally purchases sugarcane from the farmer at Rs 8 per cane. But, since his shop’s operations are expanding and the price of sugarcane has been volatile due to irregular rains hampering its production the juice seller goes for a future contract for sugarcane. The contract states that 100 sugarcane will be delivered next month and the juice seller needs to pay Rs 6.5 per cane to enter the contract. In this case, the spot price will be Rs 8 since this is the price that the juice seller will pay to get the sugarcane immediately.

The spot price is affected by the supply and demand of the underlying commodity or asset.

What is the spot price polling mechanism?

Polling is the process of drawing information from a cross-section of market players about the prevailing price of the commodity having specifications as those of the contract traded on the exchange in the market. The exchange then conducts the polling for collection of spot prices from various centres including all Basis Centres and Additional Delivery Centres spread across the country, through Polling Agencies.
Prices of the underlying commodity are polled and disseminated to the market for three basic reasons:
a. It enables polling members to take a look at the future prices.
b. Enables exchanges to study price movements and help in surveillance.
c. Determining the final settlement price on the day the contract expired.

The price for a commodity at a center is polled from a group of polling participants. The polling agency is appointed by the exchange that collects quotes from each polling participant. It subjects the prices to the statistical process of bootstrapping to arrive at the final benchmark price.

Prices are polled twice daily from market participants between 11:45 pm to 12: 30 pm and 3:45 pm to 4:30 pm. Spot prices are displayed at around 12:45 pm on all business days in the physical market.

How is the spot price calculated?

Using the trimmed mean methodology, the spot price is calculated. The trimmed mean is calculated after discarding the largest and smallest values. After removing the values the trimmed mean is found using the standard arithmetic averaging formula.

SEBI’s proposal to bring transparency in polling

SEBI has made it compulsory for the exchanges to accredit an independent polling agency under its purview to improve transparency and credibility to the spot price polling mechanism.
It has decided to come out with a consultation paper on ways to enhance efficiency in the polling methodology adopted for determining the spot price of commodities to be correct and transparent. It is essential for arriving at the expected futures prices of the commodity. Moreover, any deviation in the linkages between the two prices could lead to an adverse impact on the prices of the two derivatives and the spot market.

Shalmoli Sarkar
Shalmoli Sarkar
An MBA in marketing and a BTech in chemical engineering, Shalmoli writes on marketing strategies and business technology for new and aspiring entrepreneurs.

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