What are Commodity Derivatives? How are they different from Financial Derivatives?

What are Commodity Derivatives?

Before understanding commodity derivatives, let’s first get a basic understanding of commodities. Commodities are anything tangible that is traded on the exchange. Commodities are classified in several brackets. One of these is a raw commodity, which is produced by nature (foods and edible oil). Then there are commodities like industrial metals, energy commodities like crude oil, and bullion like silver and gold. Now, with that out of the way, let’s jump onto commodity derivatives.

Content:

Commodity Derivatives Meaning

Just like other derivatives, commodity derivative is the market where tradable goods are traded. They trade through futures, options, and swap contracts. And like other contracts, in these contracts, too, transactions are completed on a future date. 

Now, here’s a thought. The commodity market can be used as a good indicator of market sentiment. The kind of commodities that trade on the commodity market can clearly reflect the state of the economy.

Moving on. Commodities can be traded in spot markets or futures markets. In the spot market, the traders immediately pay at the current spot price. In futures markets, traders pay for a contract to receive the commodity on a future date at a set price. 

National Commodity and Derivatives Exchange

National Commodity & Derivatives Exchange Limited (NCDEX) is our Mumbai-headquartered National Commodity and Derivative Exchange. It was formed on April 23, 2003, under the Companies Act 1956. Now, NCDEX is independent and has its own independent board of directors. NCDEX provides a commodity exchange platform for the participants to trade in commodity derivatives. The NCDEX comes under the Union Ministry of Finance, essentially meaning that it is a government company.

Types of Commodity Derivatives

Just like other derivatives, commodity derivatives have four types.

Commodity Future: The commodity future derivative is the one where traders either buy or sell a fixed amount of a commodity on a set date at a fixed price.

Commodity Forward: The commodity forward derivative is an agreement between two parties who agree to exchange a fixed quantity of a commodity at a fixed price on a set future date.

Commodity Option: This contract gives the holder the right but not the obligation to execute the trade on the date of expiry. 

Commodity Swap: In a commodity swap, the floating price of an asset is traded for the agreed price over a particular period of time.

Difference Between Commodity Derivatives and Financial Derivatives

The basic concept of derivatives remains the same, no matter if it is a commodity derivative or a financial derivative. So, let’s check out the differences:

  • Most of the financial derivatives contracts are settled in cash. On the other hand, since the underlying asset exists physically, the contract settlement can happen in physical delivery, and thereby it involves logistics.
  • The quality of the underlying asset can impact the contract in the case of commodities. The concept of quality of assets does not exist in the financial market.
  • The role of exchange becomes more important in commodity derivatives as there is physical delivery involved, and the time is stipulated by the exchange. No such workload for financial derivatives exchange.

How to Buy Commodity Derivatives?

Let’s see buying commodity derivatives step-by-step

  1. First, you will need a trading account. No place better to open your trading account than Alice Blue. Alice Blue has the best and simplest platforms in the market to help traders set up their accounts and start seamless trading.
  2. Now, you need to link your bank account with your trading account.
  3. Once you have your account set up, you can find the commodity derivatives option in the menu and start trading. But, wait. You first need to ensure that your trading account has sufficient funds.
  4. Now, while trading, if you have some issues or need expert guidance, Alice Blue will be there to sort things out.

Quick Summary

  • Commodities are anything tangible that is traded on the exchange
  • Just like other derivatives, commodity derivatives are the market where tradable goods are traded. 
  • They trade through futures, options, and swap contracts.
  • National Commodity & Derivatives Exchange Limited (NCDEX) is our Mumbai-headquartered commodity and derivative exchange.
  • Commodity derivatives have four types: futures, forwards, options, and swaps.
  • The major difference between commodity and financial derivatives is in the delivery

FAQs

What is Commodity Derivatives Market?

The commodity derivatives market is a regulated marketplace where traders can buy stocks in commodities rather than companies that trade in these commodities.

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About Author

Vikas Yadav

Vikas Yadav is a professional writer who also happens to be an engineer. He's been creating content for quite some time now, but it was his fascination and zeal for the stock market that steered him in the right direction. He is eager to spread knowledge about the "power of investment" through his collaboration with Alice Blue by creating high-quality educational content for the public at large. If you want to comprehend difficult subjects in simple terms, he's your man.

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