User FAQs

1) What is a Commodity ?
A commodity is a tangible substance or product that can be traded, bought or sold.
Most commodities are raw materials, basic resources, agricultural or mining products.

2) What is a Consumption Asset ?
This is an asset held primarily for consumption.
Example - Oil

3) What is an Investment Asset ?
This is an asset held primarily for investment purposes.
Example - Cash, Equities, Bonds

4) What affects the price of a commodity ?
Supply and demand - an increase in demand will drive the price up
Storage and Transportation
Natural Disasters and Conflict
Weather -
Economic Conditions - will impact the demand for certain commodities and affect the price
Geopolitical - region instability, government policies, trade agreements
Currency Fluctuations - currency exchange rates
Speculation - activities of speculators

5) What effect would an increase in interest rates have on the price of a commodity ?
There is a historical inverse relationship between interest rates and commodity prices.
When interest rates are low, the cost of carry is low, which increases demand (there is more incentive to store)
When interest rates are high, the cost of carry is high, which decreases demand (there is more incentive to use what is stored)
When interest rates are high investors will also look outside elsewhere, outside of commodities for better returns.

6) Can you describe the Commodity market ?
These are traded in the Cash market, on Exchanges and Over the Counter

7) What are the different types of commodities ?
Energy - crude oil, natural gas, electricity, coal
Agricultural - grains, oilseeds, livestock
Metals - base, precious
Emissions -

8) What is Crude Oil used for ?
Oil is made up of long complex molecules which can be broken down into small molecules through the Oil refining process.
These smaller molecules can be used to create valuable products like gasoline, diesel and jet fuel.

9) How is Crude Oil priced ?
It is priced in US dollars
The lighter the crude oil the higher the price as it contains more hydrocarbons.

10) How is Crude Oil classified ?
There are four important measures:
API Gravity, Sulfur Content, Total Acid Number, Paraffins & Naphthenes
The higher the API Gravity the lighter the oil (between 0-50)
Sulfur content that is less than 0.5% is sweet and greater than 2% is sour

11) What are the different categories of Crude Oil ?
Brent (extracted in the North Sea/Europe) (includes Ekofisk, Forties, Oseberg, Troll)
West Texas Intermediate (WTI) (extracted in US)
Dubai Crude (includes Oman, Upper Zakum, Alshakeen, Murban)
Mars

12) What is Natural Gas used for ?
Used by power stations to generate electricity
Cooking & heating for both residential and commerical
Used in factories to help produce lost of useful materials and goods, such as glass and clothing.
An important ingredient in paints and plastics.

13) What is the main component of Natural Gas ?
Methane. This can make up around 80% of natural gas streams before processing.

14) What exchanges are Commodity Derivatives traded on ?
CME - Chicago Mercantile Exchange
 NYMEX - New York Mercantile Exchange (which included COMEX - metals, gold, silver)
 CBOT - Chicago Board of Trade (one of the oldest 1848, futures and options, trading pit)
ICE - International Exchange (specialises in energy derivaties based in Atlanta, created 2000)
LCE - London Commodity Exchange
LME - London Metal Exchange
BM&F - Brazil Mercantile and Futures Exchange

15) What are the names of some of the top commodity indices ?
A commodity index is an index that tracks the price and returns on a basket of commodities
S&P GSCI - (Goldman Sachs Commodity Index)
Bloomberg Commodity Index - (BCOM)
Rogers Interntional Commodities Index - (RICI)
Refinitiv Core CRB Index -
Deutsche Bank Liquid Commodity Index -

16) What is the Offer Price in the commodity market ?
The offer price is the lowest price at which a dealer is willing to sell a commodity.
Also called the asking price (buy price for physical markets) (offer rate for futures)

17) What is the Closing Price in the commodity market ?
The closing price is the price at the end of the day.
Also called the settlement price because its the price at which traders settle their positions and cash in or out.

18) What are the common types of commodity derivatives ?
future contracts - between two parties to buy or sell a commodity at a predetermined price on a future date
forward contracts - over the counter to buy or sell a commodity at a predetermined price on a future date
option contracts - give the holder the right (but not the obligation) to buy or sell a commodity at a specified price within a specified time period
swaps - between two parties to exchange the cash flows in the future based on the change in price of a commodity
exchange traded funds (ETF) - investment vehicles that track the price of a commodity or basket of commodities
physical delivery contracts - contract in which the delivery will take place when the contract expiries
cash settled - where profit and loss is settled in cash, rather than physical delivery

19) What is a Commodity Future ?
These are standardised contracts traded on an exchange.
This is an agreement to buy or sell a particular commodity at a future date.
The price and the amount of the commodity are fixed at the time of the agreement.
Most contracts are traded multiple times because the contracts are not held till expiry.
A standardised contract to buy or sell a commodity or security at a date in the future for an agreed price today.

20) Why would someone buy a Commodity Future ?
Producers want to lock in a price for a date in the future.
Risk Management/Hedging - Contracts are bought or sold with the intention to receive or deliver the underlying commodity. This helps to manage the future price risk of that commodity on their operations or investment portfolio.
Speculating - Contracts can be bought and sold up to the time of expiration. They allows investors to take an opinion on the direction of the market and hopefully make a profit. Before the expiry date, they will buy or sell an offsetting contract to cancel their position.

21) How do you price a Commodity Future ?
It is based on the current spot price and the cost of carry.
Futures Price = Spot Price + Cost of Carry - Convenience Yield

22) Can you give some examples of Commodity Futures ?
Brent Oil Futures (contract - 1,000 barrels, month - May 2023, exchange - ICE)
WTI Oil Futures (contract - 1,000 barrels, month, exchange - Nymex)
Natural Gas (contract - 10,000 million British thermal units (mmBtu), exchange - CME)
Container Freight Futures (exchange - CME)

23) What does Cost of Carry refer to ?
This includes any additional costs from holding the asset (holding inventory)
It includes Storage Costs, Insurance

24) What is the Convenience Yield ?
A consumption asset can have a convenience yield.
This is an additional value gained by holding the physical asset (as opposed to holding a long forward or future)
This yield is because during shortages you can sell the asset at a higher prices.

25) How do you calculate the Convenience Yield ?
This is actually very hard to calculate
You need to know: Spot price, Future Price, Time to Maturity and Borrowing Rate

26) What is Contango ?
This is a word used to describe the relationship between the spot price and the futures price of a commodity.
(Spot Price < Futures Price) - the futures price is higher than the spot price
The asset price is expected to rise giving an upward sloping forward curve.

27) What is Backwardation ?
This is a word used to describe the relationship between the spot price and the futures price of a commodity.
(Spot Price > Futures Price) - the futures price is lower than the spot price.
The asset price is expected to fall giving a downward sloping forward curve.
This can occur when there is high demand for an asset and there is a shortage in the spot market.

28) Can you give an example when backwardation would occur ?
Lets imagine there is a sudden delay in the production of West Texas Intermediate crude oil.
As a result the current supply of oil falls shortly, which means traders will rush to buy oil pushing up the spot price.
At the same time traders know this problem will be temporary so the price of futures contracts for the end of the year would remain relatively unchanged.
This would put the oil market in backwardation (spot price > futures price)
Base metals frequently exhibit a backwardation

29) What is your position when you have a Short Futures Contract ?
This person wants the price of the asset to fall.
They are locking in a selling price (before it decreases)
Once the price decreases they can buy the asset at a lower price.

30) What is your position when you have a Long Futures Contract ?
This person wants the price of the asset to rise.
They are locking in a buying price (before it increases)
Once the price increases they can sell the asset at a higher price.

31) What is the Basis ?
This is the difference between the spot price and the futures price
If spot price and futures price is the same, then basis is zero.

32) What is "Long the Basis" ?
This is a trading strategy (Long Commodity, Short Futures Contract)
This person thinks the price of the asset will fall.
They are locking in a selling price (before is decreases)

33) What is "Short the Basis" ?
This is a trading strategy (Short Commodity, Long Futures Contract)
This person thinks the price of the asset will rise.
They are locking in a buying price (before it increases)

34) What is a Futures Spread ?
The name of a popular strategy commonly used which involves simultaneously buying one futures contract and selling another to capitalise on the different in price.
This can be less risky and have lower margin requirements.

35) Can you give some examples of different Future Spread strategies
Calendar Spread - involves buying a contract for a particular month and selling a contract for a different month. Buying March 2013 and selling March 2024. There will be a lose in one leg but a profit in the other leg. If the spot price and future price is the same, then the celandar spread is zero.
Inter Market Spread - involves buying and selling two slightly different but related contracts, example Gold/Silver
Commodity Product Spread - involves buys futures for different products involved with the processing

36) What is a Rollover ?
This is when a trader moves his position from the front month contract to another contract further into the future.
This is typically two days before the expiry date.

37) What is Roll Return ?
This is an important source of return.
When the forward curve is in contango. The price of a long dated contract will slowly "roll down" towards the price of the next nearest contract. Roll return is negative.
When the forward curve is in backwardation. The price of a long dated contract will slowly "roll up" towards the price of the next nearest contract. Roll return is positive.

38) What is a Commodity Forward ?
Similar to futures but these can be for any amount and any delivery date.
An agreement to buy or sell a commodity (or commodity index) at an agreed price on a future date.
A non-standardised/ over the counter contract to buy or sell a commodity of security at a date in the future for an agreed price today.
These are Over The Counter and are not centrally cleared (ICE ?)
These have a higher rate of default than futures.
Terminal loading schedules are only published one month in advance.

39) Why would someone buy a Commodity Forward ?

40) Can you give some examples of Commodity Forwards ?
25 Day Brent (BFOET)
Brent forward contracts are from 25 days to 6 months into the future.

41) What is a Commodity Option ?
This gives the purchaser the right to buy (or sell) a particular futures contract at a futures date for a particular price.
These are standardised contracts traded on exchanges.

42) Why would someone buy a Commodity Option ?

43) How do you price a Commodity Option ?

44) Are Commodity Options European or American style options ?
Most of the CME group options are European
Most of the ICE options are American

45) Can you give some examples of Commodity Options ?
Brent Oil Futures Option - An American option to buy or sell a Commodity Future.

46) What is a Commodity Swap ?
These are linked to future contracts.
These are Over the Counter.
An agreement between two parties to exchange sequences of payments during a specified period, where at least one sequence of payments is tied to a commodity price or commodity index.

47) Why would someone buy a Commodity Swap ?

48) What is Bullion ?
A general word for physical gold and silver

49) What different types of risks are associated with trading commodities ?
market risk - price fluctuations due to changes in supply and demand
credit risk - counterparty may default
liquidity risk - not being able to sell at the desired price within a reasonable time frame
volatility risk - price movements in the underlying commodity
operational risk - failed systems, processes or human error
regulatory risk - changes in government policies and regulations
price discovery risk - not being able to get an accurate reflection of the market price for the underlying commodity

50) What is a Contract For Difference (CFD) ?
A CFD is a derivative and is an agreement between two parties to exchange the difference between a contracts opening price and closing price.
They are used to trade todays spot price with time periods up to 8-10 weeks in the future.
The time periods are usually five days in duration.

51) What does CFTC stand for ?
This is the Commodity Futures Trading Commission.
They are an independent federal agency that regulates the derivatives market including futures contracts, options and swaps in the US.

52) What does OPEC stand for ?
Organization of Petroleum Exporting Countries founded in 1960.
A group of 14 of oil-exporting countries.
Algeria, Angola, Equatorial Guinea, Gabon, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Congo, Saudi Arabia, UAE, Venezuela

53) What is OPEC+ ?
In 2016 OPEC added another 10 members including Russia, Mexico and Oman.

54) What does INE stand for ?
The Shanghai International Energy Exchange which launched its own crude oil futures in 2018.

55) What does CIF stand for ?
Cost, Insurance and Freight
this is basically the transaction cost

56) What is Tight Oil (Shale Oil) ?
This is extracted using hydraulic fracturing (fracking) and horizontal drilling.
This type of oil now represents over 60% of US Crude Oil production.
This is a very light crude oil.
Often referred to as unconventional oil because it has to be extracted using a different technique.

57) What is meant by Peak Oil ?
This is the term that is used to refer to the point in time when global oil production will start to decline.

58) What is meant by Dated Brent ?
This refers to crude physical contracts that are scheduled to load with 25 days.

59) What do the following abbreviations mean ?
BOM - Balance of Month
BOW - Balance of Week
DA - Day Ahead (delivery the following day)
EFP - Exchange of Futures for Physical
GPW - Gross Product Worth (can be calculated using the price and freight cost)
LNG - Liquefied Natural Gas
NGL - Natural Gas Liquids (such as ethane, propane, butane, pentane)
WD - Within Day (delivery within the current trading day)
WE - Weekend

60) Why is Switzerland important in the commodity trading sector ?
In the 15th century Switzerland (because of its central location) became the location where all merchants from all over Europe came to meet and exchange goods in the city square.
Switzerland is home to a large number of companies involved with commodity trading (inc. Glencore, Vale, Cargill, Vitol, Trafigura)
Swiss based commodity trading companies handle between 30-60% of all the worlds commodity trading.
Cities are Geneva, Zug and Lugano
Mediterranean Shipping Company (MSC) is the largest container shipping company in the world and it has its headquarters in Switzerland.
Denmark based Maersk is the second largest container shipping company in the world