Transcript Introduction To Commodities

Fundamentals Of Commodities
Course Structure
•
•
•
•
•
•
Course Aims
– To promote the interests of PMEX and to get people interested in safe and successful
commodity trading
Course Theory
– All theory will be geared towards promoting the present & future commodities trading
on the PMEX.
Practical Aspect Of Commodities
– Understanding PMEX. Its working and trading platform
– Ways to trade on PMEX
– How to open an account
– How to read the screen
– Understanding and learning the PMEX website
– Trip to the PMEX – to show students First Hand what its all about
Visits from PMEX Marketers and Trainers will be welcomed throughout the course
Certificates will be given at the end of course with PMEX accreditation
All help, advice, suggestions and support from THE PMEX will be welcomed AND Appreciated
Basic Trading Terminologies
•
•
•
•
•
•
•
•
•
•
Long
Bid
Margins
Initial Margin
Maintenance Margin
Variation Margin
Business Day
Exposure Limits
Delivery
Open Interest
•
•
•
•
•
•
•
•
Short
Ask
Last Traded Price
Volume Of Trading
Spot Price
Future Price
Bull Market
Bear Market
Basic Concepts
• TRADE SAFETY
– Risks and benefits of Trading
– Importance of Risk Management; Stop Loss
– Benefits of understanding and researching
markets/exchanges/commodities before trading
•
•
•
•
•
Benefits Of trading on the PMEX
Profit Objectives
Trading On Technicals
Trading on Fundamentals
Day Trading
What are Commodities and How are
we affected by them?
• Types of Commodities
– Metals
• Non-precious metals = lead, copper, aluminum, nickel – these are
usually used by manufacturers
• Precious metals = Gold, Silver, Palladium, Platinum
• These are known as hard commodities and the trade on
specialized exchanges
– Soft Commodities
• Agricultural – wheat, corn, sugar, coffee
• Energy – oil, gas, coal
• We are affected by commodities markets:
– Every time we buy a packet of tea, a cup of coffee
– Every time we buy petrol
What makes Commodities Different
(from Stocks)
• Key Features
–
–
–
–
–
–
–
–
–
–
–
High risk
Lower liquidity
They can be stolen & they can perish
Delivery is more complicated and less secure (ships sink/lorries
crash)
Are affected by politics
Are affected by weather
Most are subject to seasonal demand
Are Highly volatile
Expropriations risk
Environmental regulations
Strength of trade unions
Review Of Derivatives
Types Of People Involved in
Derivatives
• Hedgers – or those who use derivatives for risk reduction.
They may be producers of the physical commodity,
marketers, large end users – are those market participants
who buy and/or sell the assets upon which the derivatives
are based,
– They use derivatives primarily to protect against declining values
of either current commodity inventories or future production
• Speculaters –generally do not have any use for the
derivatives’ underlying assets.
– They use derivatives as a way to potentially profit from an
expected change in the price of the underlying asset and offset
any obligations that may arise out of the derivative contracts
before they expire.
• Speculators Assume the risk that hedgers offset
Futures Contracts
• Agreements between two parties to buy or sell an asset as
some point at a predetermined price.
• They trade on a regulated exchange and terms of these
contracts are standardized.
• All contracts are guaranteed by a third-party clearinghouse
associated with the exchange upon which they trade.
• The initial value of all contracts are zero, the contracts gain
value only if the futures price changes.
• Contracts have a daily settlement feature – marking-tomarket.
• All futures contracts are standardized in terms of their size,
grade, and time and place of delivery, trading hours and
minimum price fluctuations
Offsetting
• An offsetting transaction is accomplished when
the holder of a long position independently sells
the contract (or contracts), or the holder of a
short position independently buys back the
contract (or contracts)
• Payoff From the long: (offset price – Entry price) *
contract size * Number of Contracts
• Payoff From the Short: (Entry Price – Offset Price)
*Contract size * Number Of Contracts
A Typical Futures Trade
• A trader places an order with a futures broker to buy 1
July Gold (1 ounce) Futures contracts on the PMEX. The
order is filled at a price of $1494.00 .Let’s suppose the
current exchange rate is 85 rupees. The contract will
cost the trader 1494*85 =126990 rupees. The Initial
margin/token money for this contract is 3.25% of the
total amount which will be 126990*3.25% = 4127
rupees. Lets suppose the price of Gold moves up to
$1495 and the trader places an order with the same
broker to sell 1 July Gold (1 ounce) Futures contract.
The trader will then make $1*85 = 85 rupees as profit.
Rolling Over a Position
• Market Participants who still want to maintain
the same exposure to a particular underlying
asset can roll over the position into a more
distant delivery month by offsetting the old
contract while simultaneously entering into a
deferred contract month
Margin Requirements &
Marking-to-Market
•
•
•
•
•
•
Futures margin is an amount of money that a customer must deposit with a broker
to provide a level of assurance that the financial obligations of the futures contract
will be met.
Minimum margin rate for a client who wants to establish a position in a futures
market is set by the exchange or clearinghouse, but a member firm may impose
higher margin rates on its clients.
Two levels of margin are used in futures trading: initial/original margin and
maintenance margin. Original margin represents the deposit that is required when
parties first enter into a futures contract.
Maintenance margin is the minimum balance for the margin required during the
life of the contract.
Marking-to-Market=at the end of each trading day, the holder of a long position
makes a payment to the holder of a short position, or vice versa, depending on the
relationship between the current futures price and the initial entry price.
Long and short accounts are debited or credited each day by the amount of the
day’s loss or gain. The party who is in the losing position will have to deposit
additional margin only when his or her account balance falls below the
maintenance margin level.
Introduction To Gold and Silver
Why should one invest in Gold?
• Provides a safe haven for investors for the flight of
capital from risky markets
• Is seen as a hedge against inflation
• Purchasing power of strong currencies continues to fall
– a hedge against currency weakness/devaluation
• War on terrorism – the only thing that will maintain
value is Gold – its seen as a hedge against Geo-Political
Uncertainty
• Its demand & price has risen throughout time
• To attain Portfolio Diversification
Sources Of Gold Demand
• Jewelry
– Gold use in Jewelry is often Negatively Correlated with a rise in Gold
Prices
• Industrial Demand
– Used in electronic components
– Used in the medical industry
– Used for a number of decorative purposes
• New Uses Of Gold
– Used as a catalyst in fuel cells
– Used as a chemical processing agent
• Investment Demand
– Retail
– Institutional
Sources Of Gold Supply
• Mine Production
– China is the largest producer and South Africa is
the second largest
• Gold Scrap And Recycling
• Central Bank Sales
Risks And Costs Of Investing In Gold
• Pays no dividends
• There are costs to be incurred in safe keeping
• Gold does not Always provide an effective
hedge against recession
Silver as An Investment
• Silver is considered a precious metal but not as rare as gold.
• Silver is used in the production of coins, but not nearly as much
since the 1960s.
• Silver is also considered an industrial metal where about half of the
US production of silver is used in photographic film. Silver is also
used in the production of many electrical devices and of course
jewelry.
• Most newly mined silver comes from Mexico, Peru, Canada, the US,
Australia and Russia. Silver production also comes from the
recycling of camera and x-ray films, jewelry and melting of silver
coins - especially when the price of silver has been rising.
• Silver And Gold Usually Trend Together and are affected by the
same supply and demand factors
A Typical Silver Transaction
• A trader places an order with a futures broker to buy 10 July silver
futures contracts (500 troy ounces). The order is filled at $35.
Assume the exchange rate is 85 rupees. And the Initial margin
percentage is 10%
• The Initial Margin is 10% of $35*500*10*85 = 14875000* 10% =
1487500 Rupees
• Before the Expiration date of the contract, though, the trader places
an order with the same futures broker to sell 10 July silver futures
contracts The order is filled at a price of $33.
• By selling July Silver Futures, the trader has offset the earlier long
position and is no longer required to take delivery of the Silver. As
the offsetting price is lower than the entry price, the speculator has
lost US$2 an ounce, based on the difference between buying and
selling prices. As each contract represents 500 troy ounces, the
trader has lost 2*500 = $10000. or 850000 rupees
Commodity Forwards & Futures
Pricing
Main Factors For Pricing
• The price of a Commodity Forward is based on expectations
and there are several factors to consider
– Some commodities are storable
– Some are appropriate for leasing
– In some situations, there is a convenience yield to consider
• Storage costs – Cost to be considered for a buyer of the
commodity. They differ for each type of commodity.
• Lease Rate – defined as the amount of return the investor
requires to buy and then lend a commodity.
• Convenience Yield – Holding an excess amount of a
commodity for a non-monetary benefit. This usually occurs
because the owner needs the commodity for their
business.
Formulas & Explanations
•
•
F0,T = S0 eRFT = This expression says that if there are no costs or benefits associated
with buying and holding the commodity, the forward price is just the spot price
compounded at the risk free rate over the holding period.
If there are benefits (e.g., lease rates, convenience yield) to buying the commodity
today, the holder is willing to accpet a lower forward price. The forward price is
reduced by the benefit, either the lease rate or convenience yield:
– F0,T = S0 e(RF – C)T < S0 eRFT , where c is the convenience yield, or
•
•
F0,T = S0 e(RF – δ)T < S0 eRFT where δ is the lease rate
If there are costs, such as storage costs, associated with purchasing the commodity
today, the forward price is increased by the cost:
– F = S e(RF + λ)T < S eR T where λ is the storage cost
0,T
•
0
0
F
If there is a combination of costs and benefits :
– F = S e(RF + λ - c)T
– C = δ+λ
0,T
0
A Typical Example
• Calculate the 3-month forward price for a bag of rice
(100 kg) if the current spot rate is 2650 rupees/bag, the
effective monthly interest rate is 1% and the monthly
storage costs are 1.20 rupees/bag.
• First Calculate the future value (at time T) of storage
for 3 months, λ (0,T) as follows:
• 1.2 + 1.2(1.01) +1.2(1.01*1.01) = 3.63 rupees
• The amount 3.63 rupees represents three months’
storage costs plus interest. Next, add the cost of
storage to the spot prics plus interest on the spot price:
• F0,T = S0eRFT = 2733.92 rupees
Backwardation
• Occurs when the market expects lower forward prices relative to
spot prices
• Means that the forward curve is downward sloping, it occurs when
the lease rate is greater than the risk-free rate. Based on the
commodity forward formula, F0,T S0e(RF-δ1)T ,if (RF-δ1) > 0, then the
forward price must be greater than the spot price
• Is the Norm rather than the exception in the crude oil Market
• OPEC overproduces when spot prices are high, so market
participants know that when prices rise, they can expect production
levels to rise too.
• High spot prices MAY lead to exploration and redevelopment of
other oil resources, reinforcing the anticipation of higher supplies in
future leading to a lower future price.
• A risk premium or convenience yield is often placed on spot crude
oil prices
Candlestick Charting
What are candlestick charts?
• A candlestick chart is a style of bar chart used
primarily to describe price movements of a
commodity, security, currency or derivative
over time.
• It is a combination of a line-chart and a barchart, in that each bar represents the range of
price movement over a given time interval.
Why Candlestick Charts?
•
•
•
•
Candlesticks are Easy, powerful and fun to use
Using candlesticks will improve ones analysis of the market
Candlestick techniques can be used for speculation and/or hedging.
The techniques accurately reflects short-term outlooks -sometimes lasting less than eight to ten trading sessions
• Candlesticks blend perfectly with nearly all of the traders’ common
technical analysis methods, and will increase one’s understanding of
any commodity or stock issue as well as provide an incredible
insight into the market’s future price moves
• Candlesticks are especially popular because they give investors a
very clear visual image of a commodity’s progress
• Candlesticks are known to help investors take advantage of human
emotions; they can also use them to get rid of emotionally based
weakness in their own portfolios.
Characteristics of Candlesticks
• Candlesticks are usually composed of the body (black or white), and
an upper and a lower shadow (wick): the area between the open
and the close is called the real body, price excursions above and
below the real body are called shadows.
• The wick illustrates the highest and lowest traded prices of a
security during the time interval represented.
• The body illustrates the opening and closing trades.
• If the security closed higher than it opened, the body is white or
unfilled, with the opening price at the bottom of the body and the
closing price at the top. If the security closed lower than it opened,
the body is black, with the opening price at the top and the closing
price at the bottom.
• A candlestick need not have either a body or a wick.