What Are the Different Ways to Trade in Commodities

1

What Are the Different Ways to Trade in Commodities? Investors have several ways to gain exposure to commodity prices:
Physical Delivery

Traders can buy commodities and store them. For commodities that perish (eg, corn, wheat, and soybeans) or require special handling (natural gas or uranium) this method is impractical. But some commodities such as precious metals lend themselves to physical storage.

Bullion such as bars or coins is the most direct way to trade in precious metals. It just requires a secure storage facility. Some precious metals such as silver have such a low value-to-weight ratio that storing them might be too costly.
Futures
Most futures markets offer leverage to traders. As a result, traders only have to put up a small fraction of the value of the contract at first. This can produce great returns if the price of the commodity moves higher. It can also lead to big losses that the trader must then put up. Trading futures requires a high level of sophistication since factors such as storage costs and interest rates affect pricing.

Options on Futures

Options on futures are another leveraged derivative. There are two types of options: calls and puts. An owner of an option contract has the right but not the obligation to buy (in the case of a call option) or sell (in the case of a put option) a futures contract at a specific price (the strike price) on or before a certain date (the expiration date).
728x90

In other words, an option buyer can exercise a right to take a position in the futures market at or before expiration. If the option is a call, the trader can exercise the right to go long. If the option is a put, the investor can exercise the right to go short. An option will be profitable only if the price of the future exceeds the strike price (in the case of a call) by an amount greater than the premium paid for the contract.

Commodity ETFs

ETFs (exchange-traded funds) are financial instruments that trade as shares on exchanges in the same way that stocks do. Some ETFs invest in commodity futures or options on futures. Other ETFs invest in shares of companies that produce a commodity. Still, others invest in physical commodities such as bullion. While ETFs may seem like perfect proxies for investing in commodities, traders should be aware of their risks and costs. ETFs that invest in physical commodities, futures or options on futures come with the same risks and rewards that individual investments in these products do (see above).

For example, an ETF that invests in bullion would incur the same storage and security costs that individual traders do. These costs get passed on to the ETF investor. As for ETFs that invest in shares of companies, they come with the same risks and rewards of investing in individual shares (see below).
Commodity Shares

Commodity shares are a way to make a leveraged bet on commodity prices. Producers often have large initial costs to develop, explore, and produce resources. Later in their development, they have fixed costs such as salaries, rent, and debt service. However, commodity producers always have variable revenues that depend on the price of the commodity they are selling. In theory, then, investing in these companies is a way to make a leveraged bet on the price of the commodity. As the commodity’s price rises, more money should flow to the bottom line in the form of profits.

But many other factors affect the performance of a company’s share prices:
Production costs: A rise or fall in the cost of wages or equipment, for example, affects profits. Competition: The strength of competitors can affect profitability.
Interest rates: Changes in interest rates can affect the cost of debt servicing. This factor is especially big in mining, energy and utility.
Local Economies: The relative strength of the economy where a company sells its products can impact its profits.

Multiple Contraction or Expansion: The market assigns multiples to companies based on perceptions of future earnings. Changes to these can change share prices.

Contracts for Difference Contracts for Difference (CFDs) are derivative instruments that can be used to trade in commodities markets. A CFD is a contract between a trader and a brokerage firm. At the end of the contract, the two parties exchange the difference between the price of the asset at the time of the contract and the end of the contract.

Read more at: https://commodity.com/trading/

This video is aimed at anyone new to trading the commodity markets. We look at which commodities you can trade with Trading 212, and take a generalised look at the futures markets and how they help commodity producers to hedge their exposure. Test and practice your investment strategies in real market conditions with virtual money. Learn to trade and invest for free. – https://www.trading212.com/en/Practic..

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.