What is the difference between a cash market and a futures market for commodities?
Cash markets are also known as spot markets because their transactions are settled "on the spot." This can be contrasted with
Futures are a type of financial derivative in which you agree to buy or sell a certain asset at a certain price at a particular time in the future. Commodities are a type of asset representing fungible goods, such as oil, iron ore, or wheat. Commodities are usually traded using futures.
Cash Markets are the markets where assets get traded and transactions take place on an immediate basis. Derivative Markets are the markets where derivatives instruments like futures and options are traded. When you trade in cash markets, you become the owner as and when you receive the delivery.
On the other hand, the futures prices come from prices on the futures exchanges and reflect what the commodity might be worth in later months. The cash price is the amount paid for commodities on the spot market, where large manufacturers commonly purchase the commodities they need for production in their factories.
On the commodity exchanges, you only deal with derivatives. In the stock market, stock derivatives are physically settled (stock delivery). In the commodity markets, the derivatives are settled in cash. Stock markets are for both long and short-term investors.
A cash commodity is a tangible product to be delivered in exchange for payment and is seen most frequently with futures options. A contract for a cash commodity will specify the exact amount of the commodity which is expected to be delivered, along with the delivery date, and the price.
Basis - The difference between the futures price for a commodity and its cash price at a specific location. The nearby futures delivery month is usually used.
A commodity futures contract is an agreement to buy or sell a particular commodity at a future date. The price and the amount of the commodity are fixed at the time of the agreement. Most contracts contemplate that the agreement will be fulfilled by actual delivery of the commodity.
An investor with good judgment can make quick money in futures because essentially they are trading with 10 times as much exposure as with normal stocks. Also, prices in the future markets tend to move faster than in the cash or spot markets.
Commodity and equity derivative markets are two different types of financial markets that are used for different purposes. Commodity derivatives are used to hedge against price risk in the physical commodity markets, while equity derivatives are used to hedge against price risk in the stock markets.
What is the difference between cash market and equity market?
The difference between cash and equity is that cash is a currency that can be used immediately for transactions. That could be buying real estate, stocks, a car, groceries, etc. Equity is the cash value for an asset but is currently not in a currency state.
What is Basis? Basis can be defined as the difference between the clean price of the cash security minus the converted futures price.
Cash trades often get settled 2-3 days after the transaction date, while futures contracts have a pre-determined delivery date in the future that could for example be in 1, 2, or 3 months. When trading CFDs, the main difference is the cost of holding the position overnight.
The difference between the spot and futures price is referred to as Spot-Futures parity. The reason for such difference can be attributed to multiple factors such as interest rates, dividends and time to expiry. Cumulatively, these factors aid in calculating the fair value of the futures price.
It's what the commodity would cost you if you bought it today, for immediate delivery. In contrast, the futures price is delineated in a futures contract—an agreement between two parties to buy/sell the commodity at a predetermined price on a delivery date in the future.
Commodity money holds value on its own (e.g., a gold coin), whereas commodity backed money represents a specific commodity and the note or coin can be exchanged for a specific amount of the commodity with a guarantee from the issuing authority (e.g., paper money backed by gold).
A cash market is referred to as a marketplace in which financial tools like commodities and securities are purchased and received in exchange for cash. Cash markets are also known as spot markets as the transaction is settled on spot.
Commodities include agricultural products such as wheat and cattle, energy products such as oil and natural gas, and metals such as gold, silver and aluminum. There are also “soft” commodities, or those that cannot be stored for long periods of time, which include sugar, cotton, cocoa and coffee.
A commodity market trades in raw or primary products rather than manufactured products. Soft commodities are agricultural products such as wheat, livestock, coffee, cocoa, and sugar. Hard commodities are mined or extracted, such as gold, rubber, natural gas, and oil.
Possibly the biggest distinction between cash and futures trading is in delivery. While a cash trade nearly always ends with physical delivery, most futures contracts are offset before delivery, and do not result in physical delivery. Futures trading in grain markets is very active, yet rarely ends in delivery.
What are the advantages of commodity futures?
Advantages of Commodity Futures Trading
Low Margin: Commodity trading involves lower margins compared to stocks and bond markets. Traders can leverage borrowed capital, increasing exposure to commodities. In cases of cash settlement, the settled differential price allows for higher returns.
One of the features of a commodity market is that its performance demonstrates an inverse relation with both stock and bond markets, as the bond and stock prices fall when the average price level of goods rises in the economy.
The commodity futures market plays an important role in deciding the price discovery and price risk management. India is the largest consumer of commodities such as Precious metal (bullions and silver), Metal (copper, zinc, lead, etc.)
The most prevalent benefits include simple pricing, high liquidity, and risk hedging. The primary disadvantages are having no influence over future events, price swings, and the possibility of asset price declines as the expiration date approaches.
Lack of discipline is a major shortcoming.
Trading against the trend, especially without reasonable stops, and insufficient capital to trade with and/or improper money management are major causes of large losses in the futures markets; however, a large capital base alone does not guarantee success.
