Commodity Trading – Advantages & Disadvantages

Commodity futures markets allow commercial producers and commercial consumers to offset the risk of adverse future price movements in the commodities that they are selling or buying.

Advantages of commodity trading

Leverage: Commodity futures operate on margin, meaning that to take a position only a fraction of the total value needs to be available in cash in the trading account.

Commission Costs: It is a lot cheaper to buy/sell one futures contract than to buy/sell the underlying instrument. For example, one full size S&P500 contract is currently worth in excess off $250,000 and could be bought/sold for as little as $20. The expense of buying/selling $250,000 could be $2,500+.

Liquidity: The involvement of speculators means that futures contracts are reasonably liquid. However, how liquid depends on the actual contract being traded. Electronically traded contracts, such as the e-minis tend to be the most liquid whereas the pit traded commodities like corn, orange juice etc are not so readily available to the retail trader and are more expensive to trade in terms of commission and spread.

Ability to go short: Futures contracts can be sold as easily as they are bought enabling a speculator to profit from falling markets as well as rising ones. There is no uptick rule for example like there is with stocks.

No Time Decay: Stock tips suffer from time decay because the closer they come to expiry the less time there is for the option to come into the money. Commodity Tips futures do not suffer from this as they are not anticipating a particular strike price at expiry.

Disadvantages of commodity trading

Leverage: Can be a double edged sword. Low margin requirements can encourage poor money management, leading to excessive risk taking. Not only are profits enhanced but so are losses!

Speed of trading: Traditionally Commodity Tips are pit traded and in order to trade a speculator would need to contact a broker by telephone to place the order who then transmits that order to the pit to be executed. Once the trade is filled the pit trader informs the broker who then then informs his client. This can take some take and the risk of slippage occurring can be high. Online futures trading can help to reduce this time by providing the client with a direct link to an electronic exchange.