Trading Instruments in Commodities Market

Last Updated: 2 Jan 2024

The commodities market is a preferred platform for trade for some investors. However, before delving into the trading instruments available in a commodity market, it’s important to understand the definition of a “commodity” in this form of trading.

What are Commodities?

Commodities are assets or goods that are essential in everyday life. They include basic and movable goods that can be purchased and sold, except for actionable claims and money. Metals such as gold and silver, agricultural produce like sugar, wheat, and coffee are common examples of commodities. There are broadly two categories of commodities: soft and hard commodities, also known as, agricultural and non-agricultural. The price of commodities fluctuates as per the demand and supply in the market.

A Commodity Derivative is a part of commodity trading and is defined as a contract that derives its value from the commodity that will be squared off on a set future date. Commodity derivative contracts are used to reduce the risk associated with price uncertainty. To further understand how you can trade in commodities, the instruments described below provide better clarity.

What are the trading instruments in commodity markets?

Commodity derivatives trading includes both Futures and Options for trading.

Commodity Futures is an agreements to buy or sell the commodity at a set time and price in the future. Commodity Futures are available to trade in stock exchanges for participation by retail investors, corporates, and hedgers. On the other hand, Options, by nature, can be classified as calls and puts.

Calls give the buyer the right but not the obligation to buy a pre-fixed quantity of the underlying asset at a given price on or before a given future date. Puts give the buyer the right but not obligation to sell a pre-fixed quantity of the underlying asset at a given price on or before a given date.

The exchanges that offer commodity trading in India are:

• Multi Commodity Exchange – MCX
• National Commodity and Derivatives Exchange – NCDEX
• National Multi Commodity Exchange – NMCE
• Indian Commodity Exchange – ICEX
• Ace Derivatives Exchange – ACE
• The Universal Commodity Exchange – UCX

Apart from The NSE and BSE which offer stocks, bonds, and currency derivatives trading, the above-listed exchanges primarily offer commodity segments. Further, there are many types of commodity derivatives available for trading through these exchanges. They include:

• Bullions – Gold & Silver
• Base metals – Copper, Zinc & Aluminium
• Energy – Crude Oil & Natural Gas
• Pulses – Barley & Maize
• Oilseeds – Castor Seed & Soybean
• Spices – Jeera, Turmeric & Coriander

How to trade in Derivative instruments?

Many factors affect commodity prices, such as the demand and supply of the commodity, government trade policies, the global economic situation, currency movements, geopolitical tensions, market sentiments, investment funds, and seasonal cycles.

From an investor’s perspective, there are many advantages of investing in the commodities markets. These include diversification, protection from inflation, liquidity, and trading on lower margins. For retail investors, trading in the commodity market is much easier as it does not require one to have in-depth knowledge of the fundamentals in contrast to stock trading. It is majorly based on supply and demand.

For instance, if the monsoon is good, the price of agricultural commodities tends to fall, and if the monsoons are below normal, their prices may rise. Similarly, if the overall global economy is booming, the demand for commodities and prices tend to rise, whereas if the economy is in recession, the prices may fall.

With credible experience and a strong customer outreach team, IIFL is a behemoth broker in India and offers broking services in various categories of equity, commodities, currency, derivatives, and so on. Trader Terminal, the proprietary trading terminal of IIFL offers the convenience of trading in commodities by providing flexibility of access, holistic research, and expert analysis.

Final Word

Your commodity trading strategy should be developed as per the financial objectives and risk-bearing capability. With the right plan, commodity trading can prove to be profitable.