What is: Commodity Trading

What is a “Commodity”?, What is a commodity exchange? , What is Commodity Futures?

What is a “Commodity”?

Any product that can be used for commerce or an article of commerce which is traded on an authorized commodity exchange is known as commodity. The product should be movable of value, something which is bought or sold and which is produced or used as the subject or barter or sale.

What is a commodity exchange?

A commodity exchange is an association or a company or any other body corporate organizing futures trading in commodities for which license has been granted by regulating authority.

What is Commodity Futures?

A Commodity futures is an agreement between two parties to buy or sell a specified and standardized quantity of a commodity at a certain time in future at a price agreed upon at the time of entering into the contract on the commodity futures exchange.

The need for a futures market arises mainly due to the hedging function that it can perform. Commodity markets, like any other financial instrument, involve risk associated with frequent price volatility.

Major Exchanges in India

1. National Commodities & Derivatives Exchange Limited (NCDEX).
   Commodities Traded at NCDEX
   • Bullion:- Gold KG, Silver, Brent
   • Minerals:- Electrolytic Copper Cathode, Aluminum Ingot, Nickel Cathode, Zinc Metal Ingot, Mild steel Ingots
   • Oil and Oil seeds:- Cotton seed, Oil cake, Crude Palm Oil, Groundnut (in shell), Groundnut expeller Oil, Cotton, Mentha oil, RBD Pamolein, RM seed oil cake, Refined soya oil, Rape seeds, Mustard seeds,Caster seed, Yellow soybean, Meal
   • Pulses:- Urad, Yellow peas, Chana, Tur, Masoor
   • Grain:- Wheat, Indian Pusa Basmati Rice, Indian parboiled Rice (IR-36/IR-64), Indian raw Rice (ParmalPR-106), Barley, Yellow red maize
   • Spices:- Jeera, Turmeric, Pepper
   • Plantation:- Cashew, Coffee Arabica, Coffee Robusta
   • Fibers and other:- Guar Gum, Guar seeds, Guar, Jute sacking bags, Indian 28 mm cotton, Indian 31mm cotton, Lemon, Grain Bold, Medium Staple, Mulberry, Green Cottons, Potato, Raw Jute, Mulberry raw Silk, V-797 Kapas, Sugar, Chilli LCA334
   • Energy:- Crude Oil, Furnace oil
2. Multi Commodity Exchange of India Limited (MCX)
   Commodities Traded at MCX:-
   • Bullion:- Gold, Silver, Silver Coins,
   • Minerals:- Aluminum, Copper, Nickel, Iron/steel, Tin, Zinc, Lead
   • Oil and Oil seeds:- Castor oil/castor seeds, Crude Palm oil/ RBD Pamolein, Groundnut oil, Mustard/ Rapeseed oil, Soy seeds/Soy meal/Refined Soy Oil, Coconut Oil Cake, Copra, Sunflower oil, Sunflower Oil cake, Tamarind seed oil,
   • Pulses:- Chana, Masur, Tur, Urad, Yellow peas
   • Grains:- Rice/ Basmati Rice, Wheat, Maize, Bajara, Barley,
   • Spices:- Pepper, Red Chili, Jeera, Cardamom, Cinnamon, Clove, Ginger,
   • Plantation:- Cashew Kernel, Rubber, Areca nut, Betel nuts, Coconut, Coffee,
   • Fiber and others:- Kapas, Kapas Khalli, Cotton (long staple, medium staple, short staple), Cotton Cloth, Cotton Yarn, Gaur seed and Guargum, Gur and Sugar, Khandsari, Mentha Oil, Potato, Art Silk Yarn, Chara or Berseem, Raw Jute, Jute Goods, Jute Sacking,
   • Petrochemicals:- High Density Polyethylene (HDPE), Polypropylene (PP), Poly Vinyl Chloride (PVC)
   • Energy:- Brent Crude Oil, Crude Oil, Furnace Oil, Middle East Sour Crude Oil, Natural Gas

INTERNATIONAL COMMODITY EXCHANGES

• The New York Mercantile Exchange (NYMEX)
• London Metal Exchange
• The Chicago Board of Trade
• Tokyo Commodity Exchange (TOCOM)
• Chicago Mercantile Exchange

Terms used in Futures and options and commodities market

Accruals – Commodities on hand ready for shipment, storage and manufacture

Arbitragers – Arbitragers are interested in making purchase and sale in different markets at the same time to profit from price discrepancy between the two markets.

At the Market – An order to buy or sell at the best price possible at the time an order reaches the trading pit.

Basis – Basis is the difference between the cash price of an asset and futures price of the underlying asset. Basis can be negative or positive depending on the prices prevailing in the cash and futures.

Basis grade – Specific grade or grades named in the exchanges future contract. The other grades deliverable are subject to price of underlying futures

Bear – A person who expects prices to go lower.

Bid – A bid subject to immediate acceptance made on the floor of exchange to buy a definite number of futures contracts at a specific price.

Breaking – A quick decline in price.

Bulging – A quick increase in price.

Bull – A person who expects prices to go higher.

Buy on Close – To buy at the end of trading session at the price within the closing range.

Buy on opening – To buy at the beginning of trading session at a price within the opening range.

Call – An option that gives the buyer the right to a long position in the underlying futures at a specific price, the call writer (seller) may be assigned a short position in the underlying futures if the buyer exercises the call.

Cash commodity – The actual physical product on which a futures contract is based. This product can include agricultural commodities, financial instruments and the cash equivalent of index futures.

Close – The period at the end of trading session officially designated by exchange during which all transactions are considered made “at the close”.

Closing price – The price (or price range) recorded during the period designated by the exchange as the official close.

Commission house – A concern that buys and sells actual commodities or futures contract for the accounts of customers.

Consumption Commodity – Consumption commodities are held mainly for consumption purpose. E.g. Oil, steel

Cover – The cancellation of the short position in any futures contract buys the purchase of an equal quantity of the same futures contract.

Cross hedge – When a cash commodity is hedged by using futures contract of other commodity.

Day orders – Orders at a limited price which are understood to be good for the day unless expressly designated as an open order or “good till canceled order.

Delivery – The tender and receipt of actual commodity, or in case of agriculture commodities, warehouse receipts covering such commodity, in settlement of futures contract. Some contracts settle in cash (cash delivery). In which case open positions are marked to market on last day of contract based on cash market close.

Delivery month – Specified month within which delivery may be made under the terms of futures contract.

Delivery notice – A notice for a clearing member’s intention to deliver a stated quantity of commodity in settlement of a short futures position.

Derivatives – These are financial contracts, which derive their value from an underlying asset. (Underlying assets can be equity, commodity, foreign exchange, interest rates, real estate or any other asset.) Four types of derivatives are trades forward, futures, options and swaps. Derivatives can be traded either in an exchange or over the counter.

Differentials – The premium paid for grades batter than the basis grade and the discounts allowed for the grades. These differentials are fixed by the contract terms on most exchanges.

Exchange – Central market place for buyers and sellers. Standardized contracts ensure that the prices mean the same to everyone in the market. The prices in an exchange are determined in the form of a continuous auction by members who are acting on behalf of their clients, companies or themselves.

Forward contract – It is an agreement between two parties to buy or sell an asset at a future date for price agreed upon while signing agreement. Forward contract is not traded on an exchange. This is oldest form of derivative contract.

Futures Contract – It is an agreement between two parties to buy or sell a specified and standardized quantity and quality of an asset at certain time in the future at price agreed upon at the time of entering in to contract on the futures exchange.

Futures commission merchant – A broker who is permitted to accept the orders to buy and sale futures contracts for the consumers.

Futures Funds – Usually limited partnerships for investors who prefer to participate in the futures market by buying shares in a fund managed by professional traders or commodity trading advisors.

Futures Market – It facilitates buying and selling of standardized contractual agreements (for future delivery) of underlying asset as the specific commodity and not the physical commodity itself. The formulation of futures contract is very specific regarding the quality of the commodity, the quantity to be delivered and date for delivery.

Hedging – Means taking a position in futures market that is opposite to position in the physical market with the objective of reducing or limiting risk associated with price.

In the money – In call options when strike price is below the price of underlying futures. In put options, when the strike price is above the underlying futures. In-the-money options are the most expensive options because the premium includes intrinsic value.

Index Futures – Futures contracts based on indexes such as the S & P 500 or Value Line Index. These are the cash settlement contracts.

Investment Commodities – An investment commodity is generally held for investment purpose. e.g. Gold, Silver

Limit – The maximum daily price change above or below the price close in a specific futures market. Trading limits may be changed during periods of unusually high market activity.

Limit order – An order given to a broker by a customer who has some restrictions upon its execution, such as price or time.

Liquidation – A transaction made in reducing or closing out a long or short position, but more often used by the trade to mean a reduction or closing out of long position.

Local – Independent trader who trades his/her own money on the floor of the exchanges. Some local act as a brokers as well, but are subject to certain rules that protect customer orders.

Long – The buying side of an open futures contract or futures option; (2) a trader whose net position in the futures or options market shows an excess of open purchases over open sales.

Margin – Cash or equivalent posted as guarantee of fulfillment of a futures contract (not a down payment).

Margin call – Demand for additional funds or equivalent because of adverse price movement or some other contingency.

Market to Market – The practice of crediting or debating a trader’s account based on daily closing prices of the futures contracts he is long or short.

Market order – An order for immediate execution at the best available price.

Nearby – The futures contract closest to expiration.

Net position – The difference between the open contracts long and the open contracts short held in any commodity by any individual or group.

Offer – An offer indicating willingness to sell at a given price (opposite of bid).

On opening – A term used to specify execution of an order during the opening.

Open contracts – Contracts which have been brought or sold without the transaction having been completed by subsequent sale, repurchase or actual delivery or receipt of commodity.

Open interest – The number of “open contracts”. It refers to unliquidated purchases or sales and never to their combined total.

Option – It gives right but not the obligation to the option owner, to buy an underlying asset at specific price at specific time in the future.

Out-of-the money – Option calls with the strike prices above the price of the underlying futures, and puts with strike prices below the price of the underlying futures.

Over the counter – It is alternative trading platform, linked to network of dealers who do not physically meet but instead communicates through a network of phones & computers.

Pit – An octagonal platform on the trading floor of an exchange, consisting of steps upon which traders and brokers stand while trading (if circular called ring).

Point – The minimum unit in which changes in futures prices may be expressed (minimum price fluctuation may be in multiples of points).

Position – An interest in the market in the form of open commodities.

Premium – The amount by which a given futures contract’s price or commodity’s quality exceeds that of another contract or commodity (opposite of discount). In options, the price of a call or put, which the buyer initially pays to the option writer (seller).

Price limit – The maximum fluctuation in price of futures contract permitted during one trading session, as fixed by the rules of a contract market.

Purchase and sales statement – A statement sent by FMC to a customer when his futures option has been reduced or closed out (also called ‘P and S”)

Put – In options the buyer of a put has the right to continue a short position in an underlying futures contract at the strike price until the option expires; the seller (writer) of the put obligates himself to take a long position in the futures at the strike price if the buyer exercises his put.

Range – The difference between high and low price of the futures contract during a given period.

Ratio hedging – Hedging a cash position with futures on a less or more than one-for-one basis.

Reaction – The downward tendency of a commodity after an advance.

Round turn – The execution of the same customer of a purchase transaction and a sales transaction which offset each other.

Round turn commission – The cost to the customer for executing a futures contract which is charged only when the position is liquidated.

Scalping – For floor traders, the practice of trading in and out of contracts through out the trading day in a hopes for making a series of small profits.

Settlement price – The official daily closing price of futures contract, set by the exchange for the purpose of setting margins accounts.

Short – The selling of an option futures contract. (2) A trader whose net position in the futures market shows an excess of open sales over open purchases.

Speculator – Speculator is an additional buyer of the commodities whenever it seems that market prices are lower than they should be.

Spot Markets – Here commodities are physically brought or sold on a negotiated basis.

Spot price – The price at which the spot or cash commodity is selling on the cash or spot market.

Spread – Spread is the difference in prices of two futures contracts.

Striking price – In options, the price at which a futures position will be established if the buyer exercises (also called strike or exercise price).

Swap – It is an agreement between two parties to exchange different streams of cash flows in future according to predetermined terms.

Technical analysis (charting) – In price forecasting, the use of charts and other devices to analyze price-change patters and changes in volume and open interest to predict future market trends (opposite of fundamental analysis).

Time value – In options the value of premium is based on the amount of time left before the contract expires and the volatility of the underlying futures contract. Time value represents the portion of the premium in excess of intrinsic value. Time value diminishes as the expiration of the options draws near and/or if the underlying futures become less volatile.

Volume of trading (or sales) – A simple addition of successive futures transactions (a transaction consists of a purchase and matching sale).

Writer – A sealer of an option who collects the premium payment from the buyer.

Many Definitions are collected from Wiki