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What Is a Spot Premium?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 21 November 2016
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    Conjecture Corporation
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A spot premium is a term that is used to describe an arrangement by an investor to determine the terms involved with a single payment options trade or spot, and the amount of the premium that is paid to the broker. This premium is non-refundable, meaning if the conditions included in the option do not come to pass, then the investor does not recover the spot premium from the broker. This approach does help to limit risk with investing in a given asset, but does mean that the chance for at least some amount of loss is always present.

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In order to understand how paying a spot premium may be beneficial, it is necessary to have an idea of how a spot option functions. Essentially, this type of option creates an arrangement in which the investor is establishing the level of payout he or she wishes to achieve with a given investment, as well as determining the market conditions that must be in place in order for that payout to be achieved by what is known as the spot date. The broker for the deal, assuming that the terms of the spot option are agreeable, will then accept a percentage of that projected payout in the form of a spot premium and the investor can move forward with buying the option. Should the payout and the right market conditions manifest, then the investor receives the payout and the broker assesses the usual fees for executing the order. Even if the price and market conditions do not appear, the investor will lose nothing more than the premium, and owes the broker no additional charges or fees.

Depending on the potential associated with the option utilized for the strategy, the chances of losing the spot premium will vary. Should the option show excellent chances of performing as anticipated and the market moving in a direction that is in line with the conditions agreed upon between the broker and the investor, then the financial rewards can be significant. At the same time, choosing the wrong option for this type of arrangement does carry limited risk, since if the conditions are not met, the investor does not have to pay for the option on the spot date, but does lose any claim to the spot premium.

Use of the spot premium has declined somewhat after the worldwide recession that began in 2007. In a number of nations, trade regulations made it easier for investors to utilize other methods that were anticipated to make it easier for recovering markets to maintain some degree of balance. Speculation as to whether the spot option and the accompanying spot premium will see increased use in the years to come continues in many nations.

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