Trading commodity futures offers direct exposure to the underlying markets. The direct exposure combined with the leverage of futures enables traders to control valuable commodity contracts with only a fraction of the total trade amount.
What is a commodity futures contract?
Commodity futures contracts allow traders to buy or sell a commodity at some point in the future. Each contract is tied directly to the underlying market. In other words, when the price of a commodity – or the spot rate – moves up or down, the futures contract changes at the same time.
There are three main categories of commodity futures: agriculture, energy, and metals. All contracts come from raw materials like oil, natural gas, gold, silver, corn, soybeans and cattle.
Direct exposure to the spot price
The spot rate is the current price of a commodity for immediate purchase, payment, or delivery. The term spot therefore describes a price that can be carried out “on site”.
All commodity futures contracts are derived directly from the spot rate, and spot prices are internationally accepted by commodities traders around the world.
Dan Gramza, experienced international advisor to the Chicago floor trader, said: “The construction of the futures contract is naturally based on the spot price.”
For example, crude oil futures (CL) are based on the spot price of West Texas Intermediate (WTI) crude oil. As a result, CL traders are directly exposed to the spot price for crude oil. In addition, the spot price is what you would pay if you physically delivered a product.
For more information on direct exposure to raw materials, see this 2-minute video:
Challenges of the commodity exposure on the stock exchange
In contrast to the futures market, exposure to commodities on the exchange can be a challenge. While there are opportunities to get exposure to commodities in the stock markets, it is a much more indirect process with additional difficulties.
For example, there are many stocks and ETFs related to gold and gold mining, but none offer direct exposure to the spot price of gold like gold futures. Gold-based stocks are typically diversified among other metals and industries, reducing the direct correlation to the spot gold price.
Additionally, commodity-derived stocks and ETFs are sometimes discounted due to the dividends and stock structures involved. This can also reduce the association with the stock price and the spot price.
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