Commodity futures is a 2 way market

Commodity futures is a 2 way market

Buying a contract at a lower price and selling at a higher price, and booking profits, this concept is well understood and widely accepted. In commodity futures trading, one can also sell first and buy later. This concept is known as ‘short selling’.

A buyer of a futures contract is obligated to take delivery of a particular commodity or sell back the contract prior to the expiration of the contract. The latter is done by everyone usually. The purpose of shorting is to profit from a fall in prices. If one believes that the price of commodity is going down, due to oversupply and poor demand, he should go short.

Brokers and commissions

Commission is the broker’s fees for his services.

Commissions are of 2 types,

1. Discounter

Discounter type of commission is the commission where the broker charges his fees only for trading activities.

2. Full service

Full service commission is the commission charged to a broker, for advising the client regarding when to buy/sell and also providing useful analysis.

Participants

Hedgers

In a commodity market, hedging is done by a miller, processor, stockiest of goods, or the cultivator of the commodity. Sometimes exporters, who have agreed to sell at a particular price, need to be a hedger in a futures and options market. All these persons are exposed to unfavorable price movements and they would like to hedge their cash positions.

Speculators

Speculator does not have any position on which they enter in futures options market. They only have a particular view about the future price of a particular commodity. They consider various fundamental factors like demand and supply, market positions, open interests, economic fundamentals internal events, rainfall, crop predictions, government policies etc. and also considering the technical analysis, they are either bullish about the future process or have a bearish outlook.

In the first scenario, they buy futures and wait for rise in price and sell or unwind their position the moment they earn expected profit. If their view changes after taking a long position after taking into consideration the latest developments, they unwind the transaction by selling futures and limiting the losses. Speculators are very essential in all markets. They provide market to the much desired volume and liquidity; these in turn reduce the cost of transactions. They provide hedgers an opportunity to manage their risk by assuming their risk.

Arbitrageur

He is basically risk averse. He enters in to those contracts where he can earn risk less profits. When markets are imperfect, buying in one market and simultaneous selling in another market gives risk less profit. It may be possible between two physical markets, same for 2 different periods or 2 different contracts.

Intermediate Participants

Brokers

A broker is a member of any one of the futures exchange, one gets commodity or financial futures exchange, one gets the right to transact with other members of the same exchange. All persons hedging their transaction exposures or speculation on price movement cannot be members of a futures exchange. Non-member has to deal in futures exchange, through a member only. This provides the member the role of a “broker”.

Margin

Margin is money deposited in the brokerage account, which serves to guarantee the performance of the clients’ side of the contract. This is generally in the neighborhood of 2-10%

When the client enters a position, he would have deposited, the margin in his account, but the brokerage house is required to post the margin with a central exchange arm called the ‘clearing house’. The clearing house is a non-profit entity, which in effect is in charge of debiting this money to the accounts of winners daily.