So what are commodities and what is the best way to trade them? In general terms, commodites are physical goods that are usually used as raw materials in the production of other goods or services. Not only so, but in their own class, though they come from different producers, these raw materials are all the same. Oil is oil; corn is corn; silver is silver, pork bellies are pork bellies – pretty much all the same wherever you get them from. It is this “sameness” that allows them to be classified and traded in open exchange markets.
What Are Commodities Categories?
In order to form a tradable market, commodities have been classified and subclassified into various classes. The primary classes are:
Each of the above classes contain a number of sub-categories:
Energy comes in various forms and is used worldwide to provide electricty in homes and streets, power our vehicles and factories and give us the comfort of heating and cooling. So in the energy sector we have oil, which is further refined into gasoline and heating oil. Then we have coal and natural gas, as well as green energy and nuclear products.
Precious metals and industrial metals (also known as base metals) form the two subclasses of metals. Gold, silver and platinum are considered precious metals. Major industrial metals include copper, aluminum, zinc, nickel, lead, tin and palladium.
Agriculture (sometimes called “Softs”)
Agricultural produce were the first commodities to be traded and today, they remain the most important as their main product is food – a basic human need. Commodities produced from agriculture is wide ranging and includes a wide range of products like cotton, sugar, orange juice, cocoa, coffee, milk, butter and lumber.
The major livestock commodities traded today are related to hogs and cattles. They are lean hogs, pork bellies, live cattles and feeder cattles. The demand for livestock commodities tends to rise along with economic prosperity since meat products are generally more expensive.
What Are Commodities Options?
Since all the above are traded in dynamic market conditions, their prices will rise and fall according to the laws of supply and demand. This being the case, manufacturers who use these raw materials in production seek to control their risk in terms of costs. This gave birth to the commodities futures markets, where companies could secure the future price of a given commodity, or hedge against price changes in their raw material inputs.
Once the comodity futures market became well established as a standalone regulated market, there sprang another financial derivative – options on futures. Since options have limited risk (unlike futures) and a different pricing structure, they present opportunities for savvy traders.