Commodity Buying and selling – Benefits and Disadvantages

What Is Commodity Buying and selling?

Commodity futures markets enable industrial producers and industrial customers to offset the danger of hostile future worth actions within the commodities that they’re promoting or shopping for.

With the intention to work a futures contract have to be standardised. They will need to have a regular dimension and grade, expire on a sure date and have a preset tick dimension. For instance, corn futures buying and selling on the Chicago Board of Commerce are for 5000 bushels with a minimal tick dimension of 1/4cent/bushel ($12.50/contract).

A farmer could have a discipline of corn and with a purpose to hedge towards the opportunity of corn costs dropping earlier than the harvest he would possibly promote corn futures. He has locked within the present worth, if corn costs fall he makes a revenue from the futures contracts to offset the loss on the precise corn. However, a client akin to Kellogg could purchase corn futures with a purpose to shield towards an increase in the price of corn.

With the intention to facilitate a liquid market in order that producers and customers can freely purchase and promote contracts , exchanges encourage speculators. The speculators goal is to make a revenue from taking over the danger of worth fluctuation that the industrial customers don’t want. The rewards for speculators might be very giant exactly as a result of there’s a substantial threat of loss.

Benefits of commodity buying and selling

Leverage. Commodity futures function on margin, that means that to take a place solely a fraction of the entire worth must be out there in money within the buying and selling account.

Fee Prices. It’s a lot cheaper to purchase/promote one futures contract than to purchase/promote the underlying instrument. For instance, one full dimension S&P500 contract is at present value in extra off $250,000 and may very well be purchased/bought for as little as $20. The expense of shopping for/promoting $250,000 may very well be $2,500+.

Liquidity. The involvement of speculators signifies that futures contracts are fairly liquid. Nonetheless, how liquid relies on the precise contract being traded. Electronically traded contracts, such because the e-mini’s are usually essentially the most liquid whereas the pit traded commodities like corn, orange juice and many others should not so available to the retail dealer and are costlier to commerce by way of fee and unfold.

Capacity to go quick. Futures contracts might be bought as simply as they’re purchased enabling a speculator to revenue from falling markets in addition to rising ones. There is no such thing as a ‘uptick rule’ for instance like there may be with shares.

No ‘Time Decay’. Choices undergo from time decay as a result of the nearer they arrive to expiry the much less time there may be for the choice to come back into the cash. Commodity futures don’t undergo from this as they aren’t anticipating a selected strike worth at expiry.

Disadvantages of commodity buying and selling

Leverage. Is usually a double edged sword. Low margin necessities can encourage poor cash administration, resulting in extreme threat taking. Not solely are earnings enhanced however so are losses!

Pace of buying and selling. Historically commodities are pit traded and with a purpose to commerce a speculator would wish to contact a dealer by phone to position the order who then transmits that order to the pit to be executed. As soon as the commerce is stuffed the pit dealer informs the dealer who then then informs his shopper. This may take some take and the danger of slippage occurring might be excessive. On-line futures buying and selling can assist to scale back this time by offering the shopper with a direct hyperlink to an digital change.

You would possibly discover a truck of corn in your doorstep! Truly, most futures contracts should not deliverable and are money settled at expiry. Nonetheless some, like corn, are deliverable though you’re going to get loads of warning and alternative to shut out a place earlier than the truck turns up.