Commodities and Commodity Exchanges

Firstly, let us start off by understanding what commodities are. Commodities are, well commodities – Anything that can be bought and sold relatively easily, something that can physically be moved or stored. In the financial world, it could mean something as simple as gold,silver,oil,timber,sugar,wheat,cotton etc. It could also mean something as complex as a frieght contract or an interest rate swap. So, when a trader says that he is trading in commodities, it could mean that he is buying or selling any of these commodities to make a profit.

One might wonder,”What the hell would a dude sitting in Hong Kong do with 1 ton of wheat produced in Illinois and being traded on the CBOT?” Ok, traders dont physically move their commodities. More often than not, they deal with derivates pertaining to commodities i.e Futures and Options. I will talk,in detail,about derivatives some other time. For now, lets
just say that a commodity future is a contract that gives the buyer the right and the obligation to buy or sell a certain quantity of that commodity at a particular price after a particular period of time.

A commodity option gives the buyer the right but not the obligation to do the same.These futures and options can in turn, be traded.Getting back to commodities, traders can also trade in commodities without using futures or options.For example, they could buy 1 ton of cotton at X dollars and sell it a day later for a profit. The bottom line is – Profit.

A commodity exchange is a regulatory body for commodity trade.The commodity exchange sets and enforces rules pertaining to commodity and commodity derivative trade. Now, the word commodity exchange also refers to the physical location where the actual trading of commodities takes place. The most famous Commodity exchange is undoubtedly the CBOT – Chicago Board of Trade. Since it is centrally located(Midwestern USA), it traditionally was the place where the agricultural producers of the midwest and west exchanged their produce for cash from the consumers from Eastern USA. The London Metal exchange is another big commodity exchange dealing with precious metals such as palladium and platinum as well as base metals . Futures Contracts and Options are the primary instruments that traders use while trading on such exchanges.

Coming over to individuals – Yes, individuals can trade on a commodity exchange too, as long as they conform to the regulations of the exchange and have the money to invest. However, a large portion of the trading on these exchanges is done by professional traders(often part of investment banks) , by hedge funds and large associations of commodity producers to hedge against risk.

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