Commodities Trading

Commodities Trading are anything that can be bought and sold such as grains, oil, and metals.

Commodities Market are traded in the following markets:

Commodities Spot Markets

Spot markets are commodities markets where goods are sold for cash and transferred instantly. Contracts traded on these markets come into force immediately.

Commodities Spot markets are also called cash or physical markets, since prices are immediately paid in cash at existing commodities market prices. Spot settlement is done usually a couple of days from the trade date.

Commodities Spot markets also refer to a futures transaction where commodities are likely to be delivered in about a month or less. While these goods may be traded at spot prices, they are bought and sold on a forward physical market. For instance, crude oil is a future that is sold at spot prices but its actual delivery takes place in a month or less.

Commodities Forward Markets

A forward contract is an agreement entered into by two parties to purchase or sell a particular commodity at a fixed price (forward price) but with delivery on an approved future date.

Forward contractshave a long position (purchaser) and a short position (seller). Conditions are laid down at the start of the contract and no cash is exchanged until the contract matures.

For instance, if Fred wants to purchase an apartment in 6 months and Jack wants to sell his apartment in 6 months, they both enter into a forward contract. They decide on a sale price in 6 months time of $ 75,000. Fred being the purchaser has a long forward contract and Jack being the buyer has a short forward contract.

Handling Risk:

A portfolio containing assets with minimal instability reduces risk and has a positive bearing on anticipated returns. Gold is less susceptible to change and is hence a good investment.

Forwards are traded Over-the-Counter (OTC) and are a regular feature in Currency markets.

The forward price is normally compared with the spot price, which is the price at which the commodity is exchanged on the spot date. If the forward price is below the spot price, it is called forward discount. If the forward price is higher than the spot price, it is called a Forward premium.

Commodities Futures Markets

Futures are agreements to buy or sell commodities at an established price with delivery on an agreed future date. For instance, a farmer growing cotton sells a futures contract on his crop, which will be harvested later and is assured of a fixed price on future delivery. A textiles manufacturer buys the contract now for a specified quantity of cotton at an agreed price and deferred delivery. This way, the farmer is insulated against price drops and the manufacturer from price increases.

Futures contracts are traded on exchanges and are used primarily to manage risk

Commodity futures' prices are compared with spot prices. If the price of a commodity for delivery in a future date is greater than the spot price, or where a distant future delivery price is greater than an earlier future delivery, it is called "Contango". If the price of a commodity for delivery in a future date is below the spot price, or where a distant future delivery price is below an earlier future delivery, it is called "Backwardation".

Commodities Options Markets

Options are agreements that grant the entitlement but not the onus to take part in a future commodity dealing. The buyer pays a premium for the option and his risk is limited to that amount. For instance, if the buyer pays $ 450 for an option, then his loss is limited to $ 450.

An option holder will benefit by favourable price movements and will suffer losses (limited to the premium payment) in case of adverse price shifts.

Options are of two types - call and put. If the price is expected to go up, the investor will buy a call option and if the price is expected to go down, he will buy a put option.

Options can be exchange-traded or over-the-counter options between parties.

Swaps Markets

Swaps are confidential agreements between two entities to exchange cash flows in the future based on an approved procedure. A majority of swaps are traded Over-the-Counter (OTC), specially designed for the parties. However, some swaps are exchanged on futures markets.

These exchanges can be quite simple such as Yen for Pound Sterling or complicated by including multiple Commodities

Basic Trading Steps
  • seek sources containing price information like newspapers
  • Scan price tables and price charts
  • Study the opening and closing prices of commodities
  • Determine the existing price trends and follow them diligently.

Hence, the bedrock of successful trading is effectively capturingmarket sensitivities and abiding by them faithfully.