CARL WATTS & ASSOCIATES

September 20, 2010

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Securities -- Part 6
Commodities Market
TOP
Because of the huge amounts of leverage (a technique that can increase the potential return of an investment by borrowing money, which also implies greater risk) small price movements can mean huge returns or losses and a futures account can be wiped out or doubled in just minutes.
Futures contracts may also have options which limit your loss to the cost of the option.
An option is a contract that gives the buyer the right, but not the obligation, (hence the option) to buy or sell an underlying asset at a specific price on or before a certain date.

Options are divided into two categories: Calls and Puts.
An option which conveys the right to buy something is called a call; an option which conveys the right to sell is called a put.

Calls increase in value when the underlying security is going up, and they decrease in value when the underlying security declines in price.

Puts increase in value when the underlying security is going down and decrease in value when it is going up. So depending on what you anticipate happening in the market, you can buy a call or a put and profit from that movement.
Options and futures contracts are derivatives, meaning securities whose prices depend on or derive from one or more underlying assets like stocks, bonds, commo-dities, currencies, interest
Derivatives can be used for speculative purposes but are generally used as an instrument to hedge risk.

As an investor willing to take a chance in the commodity investment playground you can buy stocks or invest in mutual funds which offer stocks of companies involved in commodity-related industries (like oil companies);

Or use Exchange-Traded Funds and Exchange-Traded Notes which, like stocks, allow investors to participate in commodity price fluctuations without investing directly in futures contracts;

Or use Managed Futures through a commodity pool operator which gathers money from investors into one pool and invests it in futures contracts and options. Commodity pool operators (usually a person or a limited partnership) employ commodity trading advisers and are required to provide a risk disclosure document to investors as well as annual financial reports.

All in all, commodities trading has become an increasingly popular way for active investors to profit from global demand because it offers the opportunity for large short-term profits.

If you want to trade in commodities, be aware that it is a high risk form of trading that is not for the casual investor; you will need the help of someone knowledgeable about the structure of commodities markets, economic factors and government policies that affect commodities, and the nuts and bolts of finding and interpreting prices and market trends.
Commodities are a very complex subject involving a lot of technical terms and technicalities. In what follows I am merely touching the surface or rather trying to give you the basics on commodities and commodities trading.

Commodities are essentially goods for which there is a demand and which are supplied without qualitative differentiation across a market. They are basic resources and agricultural products. Soft commodities are goods that are grown, while hard commodities are goods that are extracted through mining.

Whether they are related to food, energy or metals, commodities maintain roughly universal prices and are fungible (meaning interchangeable or equi-valent, no matter who produces them). The priceof gold, for instance, is universal, but it can fluctuate daily based on global supply and demand.

Commodities are literally all over the world and billions of dollars are invested in them every day; the difference with commodities is that they trade in contract sizes instead of shares.

Some of the main commodities exchanges are: Chicago Board of Trade, Chicago Mercantile Exchange, New York Mercantile Exchange, London Metal Exchange, Euronext.liffe, Multi Comm-odity Exchange, Kuala Lampur Futures Exchange.

The trading of commodities through commodities markets can be made either on spot (real-time) or futures (options) markets. Note that most individual commodities are traded in the form of futures, where what is being traded is not the commodity itself but a contract to buy or sell it for a certain price by a stated date in the future.
This carries the potential for wild market fluctuations, but it also offers exciting opportunities for investors willing to ride out market volatility in anticipation of rewards.
So let’s see what it all means and how it works.

This commitment to a specificcorn buyer, but rather, through a broker, to the clearing-house of the futures exchange. The clearinghouse stands between buyers and sellers and, in effect, guarantees that both buyers and sellers will receive what they have contracted for.
Most participants in the future markets are commercial or institutional users of the commodities they trade. They are sometimes called hedgers because they can use the commodities market to take a position that will reduce the risk of financial loss due to a change in price.
Other participants, mostly individuals, are called speculators who hope to profit from changes in the price of the futures contract. They usually close down their positions before the contract is due and never take actual delivery of the commodity itself.
If you decide to invest in futures contracts you have to open up a brokerage account with a broker who trades futures and fill out a form acknowledging that you understand the risks associated with futures trading.
A commodity contract requires a minimum deposit which may differ, depending on the broker, the value of your account increases or decreases with the value of the contract. If the value of the contract goes down, you are subject to a margin call and required to place more money into your account to keep the position open.