commodities and commodity futures
TRANSCRIPT
Commodities and Commodity
FuturesBy Martin, Rishab, and Siao
What is a Commodity?Types
Interchangeable and Uniform
Basis Grade
Exchanges
CBoT, NYBoT
History of Commodities China and Sumer
Exchanges
Amsterdam Stock Exchange
1864 CBoT
Forex
Oil:
Q: CND/JPN
Differences Between Commodities and other Assets
Stocks
Bonds
Leverage
Commodity Prices Supply and Demand driven.
Factors that drive the prices:
●Production
●Inventory levels
●Costs of Storage and Transportation
Trading Commodities in the Modern Era Commodities Exchange Act 1936 -- https://www.law.cornell.edu/uscode/text/7/1
Direct:
Futures Contract, Speculation, Hedging, Spot Commodity, Arbitrage
Indirect:
Commodity ETF, Stocks in companies that deal with commodities
Spot CommoditySpot Price vs. Futures Price
Physical delivery in one month or less
“Physical Market” or “Cash Market”
Money exchanged immediately
Commodity ETFs Futures Backed
Contango Risk
Physical Backed
UWTI DWTI UGLD DGLD VelocityShare 3* leverage
Leverage
Commodity StocksMarket Factors + Company Specific Factors
Ex:
Oil Companies
FuturesSpeculators and Hedgers
Inverted Market
Types of Future Contracts:
Commodity, Political, Forex
Front Month, Back Month
History of Futures●Early futures market started with trading of wheat
●Farmers wanted a fixed return for their products
●Forward contracts to Futures contracts
Futures re: CommoditiesMain way of trading commodities - Long or Short
Buy the obligation to buy or sell the commodity.
Commodity Futures Contract Trade: ExampleExample of how a crude oil trade would look:
CL16K @ 105.52
Futures Prices for Commodities●Price Discovery
●Convenience Yield
●Spot-forward Relationship
- No arbitrage condition
- Arbitrage condition
Spot-Forward relationship under no arbitrageSpot Forward equation:
f T (t) = S(t) e(r-y)(T-t)
f T (t) = Forward rate
S(t) = Spot rate
r = interest rate; y = convenience yield
Spot-Forward Relationship under arbitrage●Cash and Carry Arbitrage
Normal backwardation
Contango
Margin Accounts●Borrowing money to trade in the market
●Typical margin accounts for equities is 50%
●But, for commodities trading, typical margin requirements is 5%-15%
For example, if you want to buy a contract of wheat futures, the margin is about $1,700. The total contract is worth about $32,500 ($6.50 x 5,000 bushels). Thus, the futures margin is about 5% of the contract value.
RiskWhat’s risky?
The chance that an investment’s actual return will be different than expected
Calculating Risk
Risk Management
Hedging, speculation, investing
Event Risk, Unsystemic Risk, and Systemic Risk
Risk in CommoditiesUnsystemic
Commodity Price Risk
Catastrophes and Global Events
Terrorism
Natural Disasters
Change in Policy
Systemic
Natural market fluctuations
SpeculationWhat is it?
High Risk High Reward
Speculating vs. Investing
ArbitrageMarket Inefficiencies
Inter-Exchange
Cash and Carry
HFT: e.g. Renaissance Technologies,
Jim Simons
Statistical arbitrage-- pairs trading: Eg. Long Gold + short Copper
What are Derivatives?Basic statistics: refer to: www.bis.org Futures
Exchange-traded & Over The Counter Traded
Underlying Asset: Almost all asset classes
E.g. ...Swaption=swap+option...is also possible (Physical Execution involved)
Vanilla options: (European & American Options)
Options on Commodity ETFs : E.g. XOP
E.g. XOP Call Option
E.g. XOP Put Option
Option PricingBlack Scholes model (European Options)
Binomial Option Pricing Model (American Options)
Monte Carlo Option Model (Exotic Options, e.g. Bermuda Options)
Option Premium = Intrinsic Value + Time Value
Intrinsic Value = |Underlying Price - Strike Price| // (ATM, ITM, OTM)
Time Value: Decreases over the time, and equals to zero at expiration
Black-Scholes Model
Assumptions: It is Theoretical
The instantaneous log returns of the stock price is an infinitesimal random walk with drift
risk free interest rate is constant
There is no arbitrage opportunity (a.k.a. No chance for riskless profit)
It is possible to borrow, lend, buy, and sell any amount, even fractional, of cash at the riskless rate.Friction free market (No transaction fee )
Leave Quants’ work with Quants…Only need to input variables:
E.g. Price of underlying
Strike, Days to Expiration,
Interest Rate,
Volatility (Implied v. Historical),
Dividend…..
Return… Greeks
Delta Sensitivity to Underlying Price Call (0,1 ) Put(-1, 0)
Vega Sensitivity to Volatility “Volatility is good”
Gamma Sensitivity to Delta Increase as option ATM, and decrease when ITM/OTM
Theta Sensitivity to Time Decaying Long: Positive theta; Short: Negative theta
Rho Sensitivity to Risk Free Rate
Hedging, “Time is valuable”Buying/ selling futures contracts to offset the risks of CHANGING PRICES in the cash market.
If a commodity to be hedged is not available as a futures contract, an investor will buy a future contract in something closely follows the movement of that commodity.
Long hedge/ Short hedge
basis = cash price - futures prices (cash refers as underlying product)
Over: P(cash) > P(future); Under: P(cash) <P(future)
Options: A right, not an obligation. What is the underlying?
Legality and StandardizationInternational Bank of Settlement:
Basel III minimum bank capital requirement
ISDA and Over The Counter (OTC) Derivatives
Central Counterparty Clearing HousesCFTC (Commodity futures trading commission)
Dodd-Frank Act (Effective 2010)
European and American clearing houses
E.g. CME Clearing
LCH. Clearnet