Everything you wanted to know about Commodities Spread Betting
Commodities Spread Trading
Records show that the first futures contract was introduced in 1851 and futures contracts have been in operation ever since. The great thing about futures is that they turn all physical goods into paper that can be traded with ease - this has enabled traders to buy and sell all kinds of things across the world without having to travel. However, trading full contracts or multiple contracts becomes extremely expensive and rules out trading for most people. In real futures trading, trading takes place in units of a single contract. Each futures contract will also have a minimum price fluctuation defined by the exchange. This is referred to as a tick or minimum tick.
Trading futures is very simple with spread betting as you can on the fluctuation of market prices on a much smaller scale and you do not have to worry about actual delivery of physical goods. Futures traders have to be sure that they either exit their trade or rollover the contract before the contract expires, otherwise they will have to deal with delivery of 10,000 barrels of oil for example. Another advantage we have over futures traders is that we do not have to pay tax on our profits as real futures traders do!
- Commodities were the first futures market which appeared in the 19th century and provided a regulated market place where producers, traders and consumers of raw materials could buy and sell forward, on margin, and hedge themselves against the risk of adverse price movements.
- Commodities consist of interchangeable goods, oil for example whether this is drilled in the Gulf or the North Sea remains the same unlike for instance burgers where there are several different varieties according to the ingredients used, taste...etc.
- All transactions take the form of futures contracts, expiring anywhere between the next mid-month and six months' time.
- Traditionally, investing directly in commodities required you to open an account with a commodity futures broker - this meant that you would not likely have been able to gain access to the commodities market for anything less than £10,000.
- Gains in commodity prices or futures are typically inversely related to the stock market, making longer term investments a great addition to a stock portfolio.
- The definition of a future is that it is an agreement to buy or sell a standard quantity of a specified asset on a fixed future date at a price agreed today. Futures that trade on an exchange are traded in standard quantities known as contracts. You can only trade in whole contracts when dealing on such exchanges; with bets, however, you can deal in whatever size you like, provided it is at least the provider's minimum bet size.
- Spread betting commodities is less expensive than trading futures directly. For instance spread bets for $1 movement in the gold price can be placed online at many firms compared with the $100 bets required for futures trading.
- One of the key differences between spread betting and actually trading 'real' futures is that with a traditional future contract you took out, if left to expire, would have meant that you would ultimately be responsible for the purchase and sale of those products.
- The delivery of futures contracts occurs on a fixed date that is known as the delivery day; for most commodities this means that on this date, money is exchanged for goods, and the goods are physically delivered. Many financial futures, such as stock index futures, are cash-settled, which means that no asset is actually transferred and instead the difference between the price of the future and the price of the underlying asset is settled in cash. All spread bets are cash-settled.
- Countries which export a lot of natural resources like the Australian and Canadian dollars (likewise for the more speculative Brazilian real, Norwegian krone and South African rand) tend to outperform when commodities are rising. This is because countries like Canada control huge resources in oil, iron ore, nickel, copper, zinc, gold, lead, silver, timber, fish, coal, petroleum, natural gas, diamond. Conversely, big natural resource importers like Japan will on the other hand are more likely to see their currencies weaken if commodity prices rise. The reverse is also true and the sudden crash in commodity prices in the second half of 2008 sent the Australian dollar from close to parity to below $0.60 against the US dollar at one point. So if you expect inflation to lead to a general increase in commodity prices you can take advantage of this by taking a long position on the Australian and Canadian dollar versus the USA Dollar.
- It is interesting to note that most commodities are traded in dollars so if the dollar falls, the commodity price will often move in the opposite direction. This is because as the dollar strengthens, less dollars are required to buy the same quantity of coal, for instance. The opposite is also true and usually as commodity prices go up, the dollar will usually lose value.
- It is thought that commodities, as represented by the CRB Index, commenced a secular BULL market in 2001. The first major upward leg in this bull market ended during the second quarter of 2006, but some analysts think that a long-term peak won't occur until at least 2008-2010. (Last update: 08 January 2007).
Contango and Backwardation
When trading commodities, especially oil and gold one of the most important points to understand is the issue known as 'contango' and its opposite 'backwardation'. If we look at contango first we can see that a dollar denominated gold futures contract will almost always be priced at a different level to the spot market price of gold in dollars. This difference has nothing to do with the way the markets work, but simply reflects the different costs of borrowing dollars and gold from the date of buying to the date of the settlement of the futures contract. In simple terms, if gold is cheaper to borrow than US dollars, which is generally the case, then the spot market price will be below the futures price. This difference between the two, is referred to as a contango, which will gradually unwind as the contract reaches expiry. The opposite of contango is 'backwardation' which occurs when the spot market price is above the futures price. So while this is all very interesting, what is the significance to us as traders? In simple terms gold traders use this information to identify turning points in market conditions.
As I have already stated above it is important to understand that spread bets are priced on futures which trade at a different price to the cash price. If we compared the cash price (aka spot price) of say silver in early March with the futures price of silver for delivery in May, we might not the prices below:
Daily Spot Silver 2002 per ounce.
May Silver 2010 per ounce.
Fair value = current cash price + cost of carry.
As you can see, the May Silver price is higher in this example than the cash price. The difference is not because your spread betting provider believes that the price is going to rise. In reality the price of a future is affected by a number of factors that take into account the cost that would be involved in holding the physical to the expiry date (the so-called 'cost of carry') as well as market sentiment.
>> Spread Betting on the Commodities Markets - Introduction
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