The general public now has a strong knowledge of various investment methods such as bonds, stocks, real estate, commodities, and many more. The commodity is one of the most popular investment methods. But it is not understood thoroughly by a large chunk of the public. They know about commodities as a method to invest, but they do not know how to invest in it, it is safe or not, and other things about commodities.
In this introductory guide to commodities options trading, we will explain everything that you need to know about commodity trading before starting your journey.
Commodity Option: Overview
There are two types of commodity options, the first one is a call option, and the second one is the put option. Understanding the working of both will help you determine how and when to use them. To every option trade, there are two sides: one is a buyer, and another one is a seller. Both sides experience the opposite outcome; if an option buyer is making money, then the option seller is losing money in the identical increment, and vice versa.Types of Options:
To take the delivery of the underlying commodity futures contract, the buyer pays a premium to the seller. This premium is treated as an asset; however, it is a liability to the seller.
- Call Options Call options give the buyer the right, but not the obligation, to buy the underlying asset at the stated strike price within a specific time.
- Put Options Put options give the buyer the right, but not the obligation, to sell the underlying asset at the stated strike price within a specific period.
Most Traded Commodities in the Market
If something is in short supply and experiences massive demand, then it is a commodity that can be traded generally. A few examples of commodities are as follows:
Agricultural products are the backbone of some countries' economies. They include edible crops like rice, corn, wheat etc. and raw material for industrial purpose such as rubber, cotton, hemp, etc.
- Orange Juice
All of the modern societies depend upon the energy to grow and thrive their economy. Fuel substances have been one of the essential commodities of the modern era.
- Heating oil
- Crude Oil
- Unleaded Gasoline
- Gas Oil
- Natural Gas
Livestock and Meat
There are so many animals in the world that are slaughtered for meat and produce more animals.
- Pork bellies
- Lean hogs
- Feeder cattle
- Live cattle
Apart from some rare metals used for industrial purposes, the metals such as gold, silver, platinum are used to enhance beauty and are prized for their malleability.
Types of Commodities Investments
Here are some types of commodities investment that people use to invest in commodities.
- The Actual Asset You can accumulate dried rice, tanks of gasoline or gold on your property. If at any moment in the world, the food supply collapses or fuels experience a severe shortage; these stored chunks of commodities will become very valuable. In such conditions, the stored commodities are the real currency, and paper money and the stock become useless.
This "Wild West" strategy of the accumulation of commodities only works if you can save the chunk in the time of emergency. Compared to sophisticated investing instruments, this type of commodity investing is less liquid.
- Exchange Traded Fund (ETF) Most of the commodity traders buy ETFs (Exchange Traded Fund). An ETF is an investment instrument that is traded on public securities markets. The markets go upwards or downwards according to the value of the underlying commodity.
Features of ETFs:
- ETFs are liquid
- Anyone can buy or sell according to their position at will.
- ETFs are like derivatives tied to the asset, but it is also separated from the asset.
- Futures Contract Future contracts are also a type of derivative that allows an investor to take a long or short position. If an investor thinks that the value of a specific commodity will go up or down, then e/she can purchase a futures contract for that particular commodity.
- Long Future Contract: If you have purchased a long futures contract, then your investment will increase in value when the value of that underlying commodity increases.
- Short Future Contract: If you have purchased a short futures contract, then your investment will increase in value when the value of that underlying contract decreases.
- Contract for Difference CFDs (Contracts for difference) are just like stock options. The investor pays the commodity exchange a fee to get the right to buy or sell a commodity at a specific price.
How CFD Works: If you think that the value of the commodity will go high, you can buy a commodity at a lower price and then sell it at a higher price and make your profit by difference. Again, if you think that the price of the commodity will go down, then you can buy at today's rate and immediately sell it at the contract price and make the profit from the difference.
The one important thing to remember is that if you get wrong, your contract will expire, and the fee is non-refundable, so in this way, it is a total loss.
How to Trade Commodities: Broker Guide
Investment in commodities is just the same as stocks or options. Most of the brokerage firms and trading platforms provide services for buying and selling commodities & the steps of trading commodities are the same as options and stocks.Step-by-Step Guide:
- The first step is to choose a brokerage firm or trading platform.
- Open a trading account on the trading platform.
- Fund your account before start trading.
- Choose the commodity or instrument out of the list that you wish to trade.
- If it is applicable to pick a short or long position, then pick one out of them.
- Now, pick the size of the trade.
- Now, control your risk with stop-loss indicators.
- Complete your trade order. You can execute it by either phone or online.
- If you use a live trading platform such as Meta Trader 4or 5, you will not have to monitor your account 24/5 because the platform will automatically monitor your positions. If it is an open position, then it will close that position at the level where stop loss or take profit level is reached.
Commodities as a Bad Investment – Analyze Risk
If an investment gives you profit, then it is not a bad investment. When a trader time the market right, then it is incredibly profitable. But, most of the leveraged investments like these carry a risk of total loss with them. If you think the value of gold will fall and it touches the sky, then every penny you have paid for this contract is lost.
- Recession During a time of recession, commodities ETFs are considered to be a bad investment. At the time of recession, assets like energy, food, gold etc., stay at their highest and ultimately go down. On the other hand, real estate and stocks perform in recession.
- Compared to Other Investments Commodities disappoint in the long term as compared to real estate and stocks. The ups and downs of commodities follow a flat trajectory. It means the commodities are good barricades against downturns.
- Extra Costs Commodity contracts also have insurance, storage, and transport costs combined in the deal. These prices do not increase or decrease with the value of the commodity. It means that the potential profit is reduced by the cushioning of the added costs.
Commodities as a Potential Profitable Investment – High Profit
Some people consider commodity investing risky. Exchange-Traded Fund and long term commodity positions could be an effective way to make a diversified portfolio.
When the value of stocks starts to decline, then the value of commodities will rise. In the economic boom time, the value of commodities stays at their lowest point by assuming no shortage of commodities. Similarly, when a nation's economy falls, the value of ETFs is likely to rise, and the value of stocks falls.
If someone knows that a specific commodity will rise or fall based upon some in-depth industry knowledge, this is called "insider trading", and the same also happens with stocks.
If you know that the value of a commodity such as gold will increase or decrease, at this time, a short or long commodity derivative is an excellent investment. But in commodities, some sure things happen the way they should. On the other hand, many people purchase stocks, hoping that the stock will rise, but the stocks do not always behave as they want.Last Thought
In this essential guide to commodities options trading, all the basic concepts of commodity trading so that the investors can use commodity trading as the right investment approach. The ideas we discussed here are what is a commodity, how it works, which are the various market forces that influence them, and different trading options.
The investors can choose to have a short term position or a long term position according to their requirements. Both of them help to build a diversified portfolio and will give you prosperity.