Commodity trading

While commodity trading shares similarities with currency and stock market trading, it has unique characteristics that require careful consideration before getting started.

Let's explore the main methods of trading commodities: futures contracts, options, and CFDs.

1. Commodity futures contracts

2. Commodity options

3. Commodity CFDs

Commodity futures contracts

Commodity futures are agreements in which you commit to buy or sell a specific quantity of a commodity at an agreed-upon price on a set future date. Futures are a popular instrument for speculating on commodity prices, as their value fluctuates based on the movement of the underlying asset.

Futures contracts were originally created to protect producers from price volatility, which could disrupt their revenue. However, today, most futures trading is conducted by speculators and hedgers rather than physical producers.

The majority of futures trades do not involve the physical delivery of the asset, as traders often choose to close their positions in cash or roll over the contract to the next expiration date.

Example of a commodity futures trade

Let's assume you believe that the price of gold will rise from its current $1,800 per ounce. You decide to buy a futures contract for 100 ounces of gold at $1,850 per ounce, with an expiration date of one month.

After one month, the price of gold increases to $1,900 per ounce, and you decide to close your position. Your contract allows you to buy 100 ounces of gold at $1,850 per ounce instead of the current market price.

As a result, you make a profit of $5,000 ($50 per ounce × 100 ounces). If you do not wish to take physical delivery of the gold, you can simply settle your position in cash or sell the contract to another trader.

However, if the price of gold drops or remains the same, you would have to close your position at a higher price, for example, $1,900 per ounce, leading to a loss.

Commodity Options

Commodity options give you the right, but not the obligation, to trade the underlying asset at an agreed-upon price—known as the strike price—before the option's expiration. You pay a premium for this right.

There are two types of options: call and put.

• Call options give you the right to buy a commodity.

• Put options give you the right to sell a commodity.

When trading options, the risk for the buyer is limited, while the potential profit is unlimited. If you purchase an option, you can choose not to exercise it, allowing it to expire worthless. Unlike futures contracts, you are not obligated to complete the trade.

If you decide not to exercise the option, your only loss is the premium paid.

Selling Options

You can not only buy options but also sell them, a practice known as writing options.

• Selling a call option means you give the buyer the right to purchase a certain amount of a commodity from you at an agreed-upon price.

• Selling a put option means you give the buyer the right to sell a certain amount of a commodity to you at an agreed-upon price.

As an option seller, you always receive a premium from the buyer, regardless of whether they execute the trade or not. However, your risk is unlimited, as the market price may significantly exceed the strike price before the option is exercised.

Most commodity options derive their value from futures markets, rather than directly from the underlying asset itself. This is important to understand, as you will need to monitor futures contract prices, which serve as the basis for determining an option's value.

Example of a commodity options trade

Let's assume you expect the price of wheat to decline from its current market price of $8 per bushel. You decide to buy a one-month put option on wheat with a strike price of $7. The current premium for this option is $0.50 per bushel. Since wheat futures contracts trade in lots of 5,000 bushels, your total premium cost would be $2,500.

By the time the option expires, the price of wheat drops to $6.50 per bushel. At this price, your put option is in the money, and you can exercise it for a profit. You would sell 5,000 bushels of wheat at $7 per bushel, rather than the new market price of $6.50 per bushel.

After accounting for the premium, your total profit would be $2,500 ($0.50 per bushel × 5,000 bushels).

However, if the price of wheat rose instead to $9 per bushel, you would face a potential loss of $1 per bushel, resulting in a $5,000 loss. In this case, you could choose not to exercise your option, letting it expire and limiting your loss to the $2,500 premium.

Commodity CFDs

Like futures and options, CFDs (Contracts for Difference) are agreements. However, with CFDs, you trade on the price difference of a commodity from the moment you open a position until you close it.

When trading commodity futures, a CFD position is based on the underlying futures market.

You do not own a futures contract directly but speculate on whether the futures price will rise or fall before the contract expires. The more the market moves in your favor, the more you profit—but if the market moves against you, your losses increase accordingly.

Example of a commodity CFD trade

Imagine you buy a CFD on WTI crude oil (US Crude Oil Future), expecting the price of oil to rise.

If your prediction is correct and the market goes up, your profit is determined by the difference between the opening price and the closing price of your position.

For example:

• If you open your position at $65 per barrel and the market rises to $75 per barrel, the difference is $10 in your favor.

However, if the market moves against you and the price of oil drops, you incur a loss based on how much the price moves against your position.

Spot commodity trading via CFDs

The spot market is the simplest form of trading, where commodities are bought and sold for cash, and the exchange is carried out immediately—or “on the spot.” Traditionally, trading on the spot market meant physically taking delivery of the commodity being exchanged. However, today, it is primarily used for speculation and hedging, similar to futures trading.

Our spot markets do not have a fixed expiration date, meaning you won’t pay rollover fees. Spot prices allow for long-term commodity trading without the need to roll over positions upon contract expiration.

These markets are priced based on underlying futures contracts, but unlike futures charts, which are restricted to a contract's expiration period, our spot markets feature continuous charts. This enables you to conduct technical analysis with extensive historical data.