A commodity market is where you can buy, sell and trade in raw or primary commodities. Commodities are of two types: Hard commodities and soft commodities. Hard commodities are gold, silver, oil, rubber etc and soft commodities are agricultural products such as coffee, sugar, corn, wheat, soya etc.
Just the way in equity trading you can trade in the cash market as well as futures market, in commodity trading also you can trade in Commodity Spots and Commodity Futures.
Commodity Spot means a commodity which is up for trade on an immediate basis. It has to be available for immediate trading as the delivery is typically settled as soon as two days.
Commodity Futures is when the investor takes a decision to buy or sell a specific commodity at a pre-decided price on a pre-decided date in the future. This is usually done to avoid any risks.
Let us know how these two markets are different from each other and how you can trade in them.
1. Trading in Commodity Spot is immediate as compared to trading in Commodity Futures
As per the name, in the spot market, if you buy or sell a commodity the delivery has to happen on the spot. In reality, this is not possible as there is a whole process involved in delivering the commodity. The two parties involved are given some 5-6 days to complete the execution of the delivery. Commodity futures, on the other hand, have a set price and date in the future for trading.
2. Commodity Spots are dependent on geography unlike Commodity Futures
As the delivery has to be done as soon as possible, commodity spots market trading is usually geographical. For example, the production of Sugar is majorly done in Maharashtra and UP. Hence spot trading for Sugar will be Maharashtra or UP specific. Commodity Futures trading happens online and hence there is no physical location involved.
3. No institutional settlement guidelines for Commodity Spots
The transaction for Commodity Futures happens on MCX and NCDEX. When settlements happen, they are done with the exchange clearing corporation with the required risk management, trade guarantee, and safeguards. In Commodity Spots, the trade is more like Over the Counter and hence the settlements happen on broadly agreed rules.
4. Commodity Futures are regulated by SEBI but not Commodity Spots
Commodity Spots are regulated by the respective state governments where commodity spot markets exist.
5. Commodity Futures are leveraged whereas Spot cannot be leveraged
If you want to trade in gold and you take a position you pay a margin of about 3%-4%. This gives you the freedom to get a 25 times leverage. SO this means that with Rs 1 Lakh you can take a position for a notional value of Rs 25 Lakhs. This is not possible in Commodity spots.
6. Prices for Commodity Spot and Futures Have a Difference
When you buy a commodity in futures there is an added cost of blocking funds and the storage of the commodity which is incurred by the seller. If there is heavy selling in the futures due to some speculations, then it more likely for the futures price to fall lower than the spot price.
Unless you need a physical delivery, Commodity futures are the preferred way of trading in Commodity markets.