Commodities are derivatives that are interchangeable with the same types of products. These assets, in some cases, are essential products that we need to live on, such as agricultural ones.
There are several types of commodities to trade on, and the availability of technology makes the market more accessible.
However, any trader who wants to trade these assets should have some clear concepts about them. Otherwise, they can end up losing money through blind trading. This article will guide you to all the basic concepts you need to know when becoming a commodity option trader.
What is a commodity option?
The term ‘commodity option’ allows the commodity holders the authority to buy at a specific price in a particular period. The buyer of the commodity option pays the seller for the authority to deliver the underlying assets or the commodity futures contracts, not for the liabilities.
On the other hand, the commodity option seller has drawbacks to sell the asset when the buyer or call option holder wants to exercise the rights to buy. So, in this case of the call option, the seller must take short positions on the market on expiry.
Remember that delivering the shorts on future contracts generally means you are long from the strike price. In this term of the commodity option, when a buyer is gaining money, the seller is losing.
Two types of commodity options are available:
- American options — allows the participants to exercise the rights of buying/selling before the expiration period.
- European options — allows participants to exercise the rights of buying/selling only after the expiration period.
Best time to use commodity options
Commodity options are not the same as other assets. When the price of a commodity option is low or ‘cheap,’ it doesn’t mean that the asset price won’t go down any further.
Similarly, when an option price is high, that doesn’t mean the price won’t go further upside. There is no extreme price level for future options. The supply and demand of the asset always drive the price for particular commodity options.
So there are no boundaries for the price of commodity options. The theoretical method such as Black and Scholes can relate to the bulging commodity option or overvaluing. For example, you can look at the 2008 financial crisis. Nothing extreme lasts forever; it comes to equilibrium for the commodity options.
Best commodities to trade
This part contains the best commodities to trade. We list these five commodities as the best tradable commodities by observing key factors such as supply and demand, liquidity, volume, and the complete price shifting of the commodity.
Gold
It is an ancient and valuable precious metal. The demand for this metal makes it an essential part of the financial world. Gold involves jewelry, dentistry, the medical industry, etc. The biggest consumer of gold in India and the largest producers of this precious metal are Australia, China, Canada, etc.
Crude oil
The next best commodity to trade is crude oil. It has increasing demand as it produces petrochemicals such as kerosene, diesel, gasoline, etc. Crude oil is a non-renewable fossil fuel type commodity with large volumes and various trading options. Several political factors affect the price of crude oil, such as war, natural disasters, etc. The Middle East is the largest crude oil producer, and the consumer is the whole world.
Aluminum
It is the next best commodity to trade as it has demand for the automobile industry, electronic industries, construction, etc. Several factors such as Chinese demand, construction industries, and transportation affect the price of Aluminium.
Neutral gas
It has become a demandable commodity over the few years as it is an environment-friendly commodity. Many industries and companies have been using it for CNG purposes. The price of neutral gas is low when you compare it with the oil price. Many expect the price of neutral gas to rise in the future.
Copper
We list copper as the fifth-best commodity to trade. The demand in several sectors, such as machinery, electronics, etc., makes copper one of the best commodities to trade. The construction market has possession over the copper price. Japan, China, India, Germany, and South Korea are the largest importers of this metal commodity.
Types of commodities
Generally, you can group commodities into four groups: metal, energy, livestock, and agriculture. These four are the primary group of commodities that are available and acceptable globally. The attributes and use are different for these groups.
- Metal commodities
They include raw materials such as gold, platinum, silver, etc.
- Energy commodities
They include crude oil, neutral gas, Brent oil, etc.
- Livestock commodities
They include cattle, eggs, etc.
- Agriculture commodities
They include soybean, grain, crops, etc.
Is commodity options trading risky?
Commodity trading involves risk as the marketplace is volatile. Especially trading commodities by future contacts is a risky investment. Several risk factors embrace commodity trading, such as reputational or legal risk, currency risk, contract performance risk, political risk, etc. It is not unnatural that commodity prices can double, triple, or more in a short period.
However, investing in commodities may be risky for small investors. Still, the professionals can make continuous profits and grow their wealth gradually from commodity trading.
Final thoughts
Finally, now you know the types of commodities and the best commodities to trade. You can trade commodities with a bit of investment by using the broker’s leverage and margin features to their clients. In this article, you know the fundamental factors of commodity trading.
We suggest doing more research and getting sufficient knowledge about the commodity market before starting to trade. You can end up losing all your trading capital if you try to trade commodities without proper knowledge and strategy. If you can master the best methods and techniques for trading commodities, you are just one step away from achieving your financial freedom.
