Contracts in Commodities Market
Posted By:- Ilan Levy-Mayer Vice President, Cannon Trading Futures Blog
What is an Online Commodities Futures Trading Contract?
Online trading of commodities futures creates a commodities contract, which is a legal agreement between two parties. The contract specifies that you agree to buy or sell a product or asset to be “delivered” later at a certain price. The buy/sell price is called the future price of the underlying asset. Commodities futures brokers can assist you in online commodities trading.
Commodity Markets and the Stock Market
Over my years as a commodity broker, my brain tended to think of the following correlation: when stocks are “hot”, commodity markets tend to under perform. When stocks tumble, commodity markets tend to do better.
As the years progressed and the markets evolve, as they always do, my brain started thinking along the lines of “when crude oil futures are hot, commodity markets start sizzling…”
Then a few years went by and the same brain, just a bit older started whispering….”when the dollar index is strong, commodity markets tend to get weaker…..”
The bottom line is that all of the statements above were true at one point or another and some may be true as you are reading this BUT the main conclusion should be:
Commodity markets compromise of many different markets and segments like grain futures, energy markets, softs, meats, metals and much more. These markets are all affected by some mutual elements like dollar strength but also by very specific elements like supply and demand, weather, geo political and much more.
Do your homework and just like the commodity futures markets, keep evolving, evaluating and educating yourself.
Types of Investors
There are two kinds of participants in online commodities trading markets: hedgers and speculators. Hedgers don’t necessarily seek to profit by trading commodities futures; they are striving to stabilize their income and expenses (the costs of their business operations). This allows them to make a budget and predict their costs to their investors and board of directors. Most speculators do not want to physically take possession of the underlying asset: they do not want truckloads of corn dumped in their driveway. Speculators are betting on the future prices of certain commodities. They have the power to cause dramatic price swings in the futures markets, but they also provide liquidity – the ability to sell an investment at its near-value – to the futures markets.
Types of Contracts
Futures are standardized contracts traded on an exchange. In 1848, the Chicago Board of Trade (CBOT) was established and is one of the oldest futures exchanges in the United States. Other major futures trading exchanges include:
- Chicago mercantile exchange (CME)
- New York Board of Trade (NYBOT)
- Intercontinental Exchange (ICE)
- London Metal Exchange (LME)
- Multi Commodity Exchange (MCX)
- New York Mercantile Exchange (NYMEX)
Derivatives are contracts where the value (price) of the underlying security is based on a similar asset or product (“real asset”). With derivatives, the underlying security can be bonds, commodities, currencies, indexes, or stocks.
The most important point to remember about derivatives is that the value of the derivative depends on something else, which is the underlying asset. This means that when the value of the underlying asset changes, it causes the price or value of the derivative to change as well.
How Does a Commodities Contract Work?
Classifications of commodities futures trading contracts include:
- Deliverable, storable commodities; fruits, grains, lumber, oil and its derivatives
- Financial Futures contracts such as currencies, bonds, and notes that are deliverable
- Financial Indices that are cash-settled
Each contract is unique. Each Standardized futures contract usually specifies:
- The quantity of the commodity or unit
- Grade that is deliverable; for example, #2 Yellow Corn, 30-year Bonds not less than 17 years or more than 22 years
- Settlement Method with minimum contract price fluctuation
Commodities Futures Options
The two types of options market contracts are put and call options, which can be purchased to speculate on the direction of all futures contracts or sold to generate income.
Call options give buyers the right to buy an underlying futures contract at the specified strike price within a specified time. The buyer can sell the option at any time. The seller of a call option delivers a short position in the underlying futures contract from the strike price, if the buyer chooses to exercise that option.
A call option is in the money if the futures contract price is higher than the strike price.
Put options give the buyer the right to sell the underlying commodities futures contract at the strike price within a specified time. The seller of a put option receives a long position in the underlying futures contract if the buyer chooses to exercise that option. A put option is in the money when the underlying contract price is below the strike price; this is called the intrinsic value.
An option is out of the money if the price of the underlying assets remains below the strike price (call) or above the strike price (put). At-the-money options are at or very close to the strike price.
FYI (For Your Information)
All participants in an online futures trading contract must declare collateral, known as margin, which is set at a percentage of the value of the futures contract (about 3-15%.) The margin requirements can change – depending on the futures contract being traded – and must be maintained by the buyer and the seller for the life of the futures contract.
- Commodities futures trading contracts always have an expiration date.
- Even though a futures contract defines delivery of a commodity/asset, the buyer and seller can – independently of each other – liquidate at any point without actual delivery.
- There is no interest charged on the difference between the margin and the total value of the contract.
- When you buy a commodities futures contract, you are said to be long on the market; as a seller, you are short on the market.
- Where stocks’ gains/losses are realized after the sale of the stock currently Trade date + 3 days, commodities futures contracts’ gains and losses are settled at the end of each day.
Commodities Futures Trading: Cannon Trading 2016 Star Award Winner
Cannon Trading commodities futures brokers have been guiding new traders toward knowledge and financial growth in the marketplace for over 30 years. Successful commodities trading, superior service, and relationship-building are part of our professional trading company’s mission. and we offer reasonable, affordable commission rates. In fact, we offer some of the lowest commission rates in the industry. Call 310.859.9572, 800.454.9572, or contact us to learn more. Today is not too soon.
Important: Trading commodity futures and options involves a substantial risk of loss. The recommendations contained in this letter are of opinion only and do not guarantee any profits. There is not an actual account trading these recommendations. These are risky markets and only risk capital should be used. Past performances are not necessarily indicative of future results.