Commodity Trading – Advantages and Disadvantages

What Is Commodity Trading?

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

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

A farmer might have a area of corn and so as to hedge towards the opportunity of corn costs dropping earlier than the harvest he may 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. On the opposite hand, a shopper similar to Kellogg might purchase corn futures so as to defend towards an increase in the price of corn.

In order 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 business customers don’t want. The rewards for speculators might be very massive exactly as a result of there’s a substantial threat of loss.

Advantages 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.

Commission Costs. It is quite a bit cheaper to purchase/promote one futures contract than to purchase/promote the underlying instrument. For instance, one full measurement S&P500 contract is at the moment price in extra off $250,000 and might be purchased/bought for as little as $20. The expense of shopping for/promoting $250,000 might be $2,500+.

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

Ability 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 not any ‘uptick rule’ for instance like there’s with shares.

No ‘Time Decay’. Options endure from time decay as a result of the nearer they arrive to expiry the much less time there’s for the choice to come back into the cash. Commodity futures don’t endure from this as they don’t seem to be anticipating a specific strike worth at expiry.

Disadvantages of commodity buying and selling

Leverage. Can be 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!

Speed of buying and selling. Traditionally commodities are pit traded and so as to commerce a speculator would wish to contact a dealer by phone to put the order who then transmits that order to the pit to be executed. Once the commerce is stuffed the pit dealer informs the dealer who then then informs his consumer. This can take some take and the danger of slippage occurring might be excessive. Online futures buying and selling will help to cut back this time by offering the consumer with a direct hyperlink to an digital trade.

You may discover a truck of corn in your doorstep! Actually, most futures contracts usually are not deliverable and are money settled at expiry. However 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.

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Source by Tim Wreford

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