What are commodity futures?
Trading in commodity derivatives first started to protect farmers from the risk of the value of their crop going below the cost price of their produce. Derivative contracts were offered on various agricultural products like cotton, rice, coffee, wheat, pepper, etc.
A commodity futures contract is a contractual agreement between two parties to buy or sell a specified quantity and quality of commodity at a certain time in the future at a certain price agreed at the time of entering into the contract on the commodity exchange.
The expiry dates for different contracts can vary from one contract to another. In commodity derivatives, a buyer and a seller agree upon a price where the buyer is obliged to buy the commodity, and the seller is obliged to deliver the commodity on the pre-specified date and price.
Why trade in commodity futures?
Commodities are natural resources used in day-to-day life. Unlike financial futures; commodity futures do not carry the risk of investors going bankrupt or declaring losses. Commodities have upper and lower price bands. i.e. Beyond a certain price level commodity prices cannot fall as the producers will stop their production and commodity prices cannot rise beyond a certain price level as people will look for the availability of substitutes.
Futures trading in commodities is transparent and facilitates fair price discovery on account of the large-scale participation of entities associated with different value chains and reflects the views and expectations of a wider section of people related to that commodity. This also provides an effective platform for price risk management for all segments of players ranging from the producers, the traders, processors, exporters/importers, and the end users of the commodity.
In commodity futures, it is necessary to distinguish between investment commodities and consumption commodities. An investment commodity is generally held for investment purposes whereas consumption commodities are held mainly for consumption purposes. Gold and Silver can be classified as investment commodities whereas oil and steel can be classified as consumption commodities.
Is commodity trading only available in India?
Commodity trading has been available in India since 1875 with several exchanges providing opportunities to invest in commodities like gold, wheat, corn, oil, and others. It is a very popular trading practice all over the world, with four registered exchanges in India. Most of the developed and developing countries have their own commodity markets. The first commodity exchange (Chicago Board of Trade - CBOT) was started in 1848 in the United States. Even a communist country like China has its own commodity exchanges, making it a popular concept in the rest of the world.
What are the advantages of commodity futures trading?
The commodity derivatives market is a direct way to invest in commodities rather than investing in the companies that trade in those commodities.
For example, an investor can invest directly in a steel derivative rather than investing in the shares of steel companies. It is easier to forecast the price of commodities based on their demand and supply forecasts as compared to forecasting the price of the shares of a company -- which depend on many other factors than just the demand and supply of the products they manufacture and sell or trade-in.
The basic advantage of commodity futures trading is for hedgers and for users of that commodity. A farmer may hedge his upcoming harvest at higher prices in the commodities markets to avoid any downfall in the market price in the future while an automobile company may hedge its copper requirement at lower prices to secure its supply against any price rise in the future. For an investor, it is an alternate investment class.
What is the difference between commodity trading in cash and futures?
Commodity trading in cash refers to spot dealing in commodities where payments and delivery are made immediately. Futures trading in commodities refers to a contract where delivery and payment will be made at a pre-fixed future date or time. In cash trading, the entire payment is made while in futures trading only a small percentage of the entire contract value (margin) needs to be paid immediately.
What commodities are available for trading?
The following commodities are available in commodity trading:
Precious Metals: Gold, Silver Platinum
Energy: Crude Oil, Natural Gas, Furnace Oil
Base Metals: Aluminum, Copper, Nickel, Zinc, Lead, Steel ingots
Agriculture: Soybean, Soya Oil, Chana, Palm Oil, Jeera (Cumin seeds), Pepper, Turmeric, Chilli, Cardamon, Guar Gum, Guar Seed, Mentha Oil, RM seed, Sugar.
