Learn About Commodities Trading

Written by Jacey Harmon
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A commodity can be broadly defined as anything that can be bought or sold. Traditional commodities include: corn, soybeans, oil, gasoline, sugar, and orange juice. Yet, bonds can be considered a commodity and so can cash. Commodities are traded in two markets: cash and futures markets. The cash market is where the buyer and seller meet directly and exchange goods. A cattle auction would be a good example of a cash market.

In the futures market, buyers and sellers don't meet. In fact, very few of those involved with the futures markets are involved with the underlying commodities. The majority of futures traders are speculators that have no interest in delivering or taking delivery of the underlying commodity. Speculators use the market simply to make a profit on commodity price fluctuations. Producers that are involved with the futures market use it to hedge their risk against adverse price movements: this is called hedging.

Trading Commodities Futures

Commodities futures are traded on exchange floors. There are several exchanges in the United States, each trading specific contracts. The New York Mercantile Exchange (NYMEX) trades energy commodities while the Kansas City Exchange trades wheat contracts. There are some commodities that are traded on more than one exchange. For example wheat is traded in both Chicago and Kansas City. Each exchange's website will state what contracts are traded there.

A futures contract can be defined as: an obligation to buy or sell a specific amount of a commodity, on a specific date in the future, at a price agreed upon today. This future delivery of the commodity is why these contracts are called futures. Each contract carries various specifications: the amount of commodity to be delivered. This specification is integral in valuing and trading the contract.

Commodities futures are quoted on a single unit basis. For example, the NYMEX Brent Crude contract controls 1,000 barrels of oil. The contract is quoted on a per barrel basis. So if the contract is quoted at $50, the contract is worth $50,000. For every 1$ move in the price of oil, the contract would gain $1,000. Each contract specifies the month the commodity is to be delivered. In order for a trader to be released from the obligation to deliver or buy the commodity you simply place an offsetting trade: buy if you have sold, sold if you have bought.

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