Day Trading

Stock Option Trading – Commodity Futures   by Robert McClure

What is a future?

A futures exchange or derivatives exchange is a central financial exchange where people can trade standardized futures contracts; that is, a contract to buy specific quantities of a commodity or financial instrument at a specified price with delivery set at a specified time in the future.

A commodity is a good for which there is demand, but which is supplied without qualitative differentiation across a market. Commodities are often substances that come out of the earth and maintain roughly a universal price. A commodity is fungible, that is, equivalent no matter who produces it. Examples are petroleum, notebook paper, milk, and copper. The price of copper is universal, and fluctuates daily based on global supply and demand. Stereo systems, on the other hand, have many aspects of product differentiation, such as the brand, the user interface, the perceived quality etc. And, the more valuable a stereo is perceived to be, the more it will cost.

In contrast, one of the characteristics of a commodity good is that its price is determined as a function of its market as a whole. Well-established physical commodities have actively traded spot and derivative markets. Generally, these are basic resources and agricultural products such as iron ore, crude oil, coal, ethanol, salt, sugar, coffee beans, soybeans, aluminum, copper, rice, wheat, gold, silver, palladium, and platinum. Soft commodities are goods that are grown, while hard commodities are the ones that are extracted through mining.

There is another important class of energy commodities which includes electricity, gas, coal and oil. Electricity has the particular characteristic that it is either impossible or uneconomical to store, hence, electricity must be consumed as soon as it is produced.

Com-moditization occurs as a goods or services market loses differentiation across its supply base, often by the diffusion of the intellectual capital necessary to acquire or produce it efficiently. As such, goods that formerly carried premium margins for market participants have become commodities, such as generic pharmaceuticals and silicon chips.

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About the Author

Futures traders are traditionally placed in one of two groups: hedgers, who have an interest in the underlying asset (which could include an intangible such as an index or interest rate) and are seeking to hedge out the risk of price changes; and speculators, who seek to make a profit by predicting market moves and opening a derivative contract related to the asset “on paper”, while they have no practical use for or intent to actually take or make delivery of the underlying asset. In other words, the investor is seeking exposure to the asset in a long futures or the opposite effect via a short futures contract. Hedgers typically include producers and consumers of a commodity or the owner of an asset or assets subject to certain influences such as an interest rate.

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