4 Tactics Employed by Commodities Traders

Commodities traders tend to engage in riskier tactics than those who trade in other areas of the market. This is a generalization, and there are still some commodities traders who engage in, for example, simplified gold bonds. However, the commodity market is considered a riskier market than the general securities market, so the types of investors and traders called to this unique area are typically hungry for risk. They fulfill this hunger with tactics that go beyond simply investing and hoping for profits. 

#1 Exercising Options

An options contract allows a buyer or seller to lock in a future price today. This is a necessary part of the market on one hand, because it allows the many players to hedge and speculate on prices to keep their returns more stable against fluctuation. When a speculator, the investor, signs an option contract, he or she is hoping the price at the time the option is exercised is actually higher than the option price. If this is the case, the speculator can call the option, using the profits to purchase more of the commodity, creating a lower cost per unit. Options sometimes are successful and sometimes are not, but they are an integral part of the commodity trade.

#2 Purchasing Futures

Futures are similar to options because they require traders to speculate on prices at a given time in the future. For example, a speculator, or trader, will set a future contract to agree to purchase 100 barrels of oil at $100 each at a date in the future. In this example, the current price of oil is only $95 a barrel. However, the speculator believes the price will climb to $110 when the future matures. If this happens, then the purchaser can buy the oil at $10 lower per barrel than the market price and sell the barrels for a profit.

#3 Short Selling

Shorting is a tactic used in all areas of the market. With a short sale, a trader borrows a commodity from a brokerage house. He or she sells the commodity and buys it back before the debt expires. If the price of the commodity drops during that time, the individual can buy the item back to repay the debt at a much lower expense than he or she sold it for. The result is an immediate profit by accurately predicting a fall in prices. Selling short is a controversial technique because it involves hoping the price of a good will decline.

#4 Commodity Swaps

Swaps also exist in multiple areas of the market. With a swap, one owner of a commodity agrees to trade its revenue stream for the revenue stream of another owner's commodity. This can be confusing, so consider this simple scenario: Bob owns three cows that will sell for $200 each next month, Theresa owns 6 chickens that will sell for $100 each next month. Bob and Theresa, through their brokers, agree to trade profits. The cows go up in price, and they sell for $250 each; the chickens sell for only $75 a piece. Theresa turned her $600 expected profit into $750. Theresa made the better swap.

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