Understanding Commodities Pricing
Trading commodities can be intimidating. After all, futures contracts are highly leveraged and the markets are often volatile. However, aside from the risks involved many traders find a majority of their frustration in getting comfortable with how each contract is quoted, what the point value or multiplier of each contract is and most importantly how to calculate the profit, loss and risk of a trade.
Each commodity futures contract is standardized but in comparison to those with differing underlying assets they are often worlds apart. This can be extremely overwhelming for a new trader; I hope that the following explanations shorten your learning curve and give you the information that you need to begin your journey in the challenging yet lucrative trading arena known as options and futures.
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Foods or Softs
Coffee, orange juice, cocoa and sugar all fall into a category often referred to as the “softs”. With the exception of cocoa, each of these contracts are quoted in cents per pound. Accordingly, although the multiplier will be different the methodology in figuring out profit, loss and risk on a trade will be very similar to that of meat futures. Cocoa, on the other hand is quoted in even dollar amounts per ton and prices are not broken down into cents. In other words, if cocoa is trading at 2100, it is actually going for two thousand one hundred dollars per ton. There are ten tons in a contract, so if the daily price change is +14, multiply by ten or add a zero to get the true dollar amount. In this case a trader would have either made or lost $140. If this confuses you, you can simply multiply the change in price by $10.
Coffee trades in contracts of 37,500 pounds making each penny of movement worth $375 to the trader. For example, if prices move from 120.00 to 121.00 a trader would have made or lost $375 before considering transaction costs. The decimal point isn’t meant to separate dollars from cents it is a way of breaking each penny into fractions of a penny. Thus, if the price rises from 120.50 to 120.00 it has appreciated by half of a cent.
Orange Juice Futures
An orange juice contract represents 15,000 pounds of the underlying product. Therefore, each cent of price movement results in a profit or loss of $150 to a trader. Like the meats and coffee, orange juice is quoted in cents per pound with a decimal that simply represents a fraction of a cent. A trader long orange juice from 120.00 with the current market price at 118.50 has an unrealized loss of 1.5 cents or $225 (1.5 x $150).
Sugar #11 (not #14) futures are traded based on a contract size of 112,000 pounds. With that said, each tick in sugar is worth $11.20 to the trader and each full handle of price movement (or penny) is equivalent to $1,120. Once again, don’t mistake the decimal for separation of dollars and cents. If sugar is trading at 12.20 cents it will be displayed by a quote service as 12.20. A trader long from 11.95 would be profitable at 12.20 by .25 cents, or $280, figured by multiplying the difference between the current price (12.20) and the purchase price (11.95) by the point value ($11.20).
Cotton isn’t a food, it is a fiber. Nonetheless, it is most often grouped with the softs because it trades on the same exchange. Cotton futures trade in 50,000 pound contracts and are quoted in cents per pound; again, the decimal point isn’t intended to separate dollars and cents. Rather it separates cents from fractions of a cent. In other words, if cotton is trading at 68.50 it is read as 68 1/2 cents. Due to the contract size, each tick of price movement is worth $5 to a trader; therefore if a speculator sells cotton at 65.40 and is stopped out with a loss at 67.30 the total amount of the damage would be 1.9 cents or $950 (190 points x $5).
Lumber futures are not traded on ICE with the other softs, but are often referred to in the same category. For reasons unknown, lumber futures attract beginning traders. Perhaps it is because it is the epitome of the definition of a commodity due to its widespread usage. Nonetheless, it is a sparsely traded contract by speculators and until liquidity improves I don’t necessarily recommend trading it. I have only walked by the lumber trading pit once (at the CME before merging floors with the CBOT) and there were three market makers passing the time by reading a newspaper and playing solitaire. As a speculator, it is never a good idea to trade in a market in which your order will be one of a handful of fills in the entire trading day.
If you do insist on trading lumber you must be willing to accept wide bid/ask spreads and a considerable amount of slippage getting in and getting out of your position. The contract size for lumber is 110,000 board feet and it is quoted in dollars and cents. Accordingly, each tick of price movement represents $11. In this case, the decimal is used in its usual context. If the market is trading at 246.80, it is interpreted as $246.80.
Precious Metals Futures
Gold, Platinum and Palladium Futures
Gold, platinum and palladium are quoted just as they appear, the decimal included in the quotes are intended to separate dollars and cents. The numbers to the left of the decimal are dollars and the numbers to the right are cents. In other words, a point in these metals contracts is synonymous with a cent. For example, if gold is trading at 830.20 and rallies 60 cents the price will be 830.80, or simply $830.80. Platinum and palladium are treated the same; there are no surprises here. However, their point values do differ. Palladium has an equivalent point value as gold, $100 per dollar of price movement but the point value and contract size of platinum is half of that of gold and palladium.
A gold futures contract represents 100 ounces of the underlying commodity. Each penny of price movement results in a profit or loss of $10 to the trader and each full dollar movement in price represents $100 of profit or loss. Accordingly, if gold rallies from $849.20 to $856.80 a long trader would have made $7.60 or $760 and a short trader would have lost that amount (not considering commissions and fees).
856.80 – 849.20 = 7.60
7.60 x $100 = $760 (minus commissions and fees)
The manner in which silver futures are quoted is more similar to grains such as corn and wheat than it is the other precious metals. A silver contract represents 5,000 ounces of the underlying commodity creating a cent value of $50. With that said, for every penny that the futures market moves a trader will make or lose $50. Likewise, silver trades in fractions of a cent. If the price is quoted as 1634.5 it should be read as $16.34 1/2. Please note that the CBOT version of the silver contract trades in tenths of a cent such as 1634.1 or sixteen dollars and thirty four and one tenth of a cent.
Calculating profit and loss in silver is identical to doing so in corn, wheat or soybeans. If you sell silver at 13.450 ($13.45) and are stopped out at 1362.5 ($13.62 1/2) you would have lost 17.5 cents or $875 ($50 x 17.5).
Unlike the other metals which are referred to in terms of cents per ounce, copper is quoted in cents per pound. The contract size is 25,000 pounds making the multiplier $250 for a penny move. Simply put, if copper rises or falls by one cent a futures trader would make or lose $250. This makes sense because if the price of copper goes up by 1 penny you would make 25,000 pennies on a long futures position. Also unlike gold futures, copper prices trade in fractions of a cent. If you see copper quoted at 3.055 it is trading at $3.05 1/2. Likewise, if copper rallies from this price to 3.450, it represents a gain of 39.5 cents or $9,875 ($250 x 39.5) per contract. This sounds great if you happened to be long, but a short trader during this move likely lost a lot of sleep.
Crude oil is one of the most talked about commodities but is also one of the most challenging markets to speculate. Light sweet crude (not to be confused with brent crude) is quoted in dollars per barrel. From a trading standpoint, it is relatively simple to calculate profit, loss and risk due to the fact that it is quoted in dollars and cents as we are accustomed to in everyday life. The contract size is 1,000 barrels, so each penny of price movement in crude represents $10 of risk to a commodity trader.
A price quote of 120.00 is just as it appears, $120.00 per barrel of crude. A drop in price from 120.00 to 118.00 is equivalent to a $2,000 profit or loss for a futures trader. Remember, each penny is worth $10 to a trader and a $2 move in price is 200 cents.
Heating oil and unleaded gasoline are much more complicated to figure. Both are quoted in cents per gallon, similar to how it is displayed to you at a gas station pump. Consequently, in both cases the decimal point separates the dollars from the cents and each of them trade in fractions of a cent. The contract size for each is 42,000 gallons, so each point in price movement is worth $4.20 cents to a futures trader and each penny (100 points) is worth $420. For example, if heating oil is trading at 4.1060 ($4.10 6/10) and rallies to a price of 4.2140 ($4.21 4/10) the futures contract has gained 10.8 cents or $4,536 (10.8 x $420). By this example you can see how easily money can be made or lost in the futures market. A price move of less than 11 cents could result in a profit or loss of several thousand dollars.
Natural gas is quoted in BTU’s or British Thermal Units which is a measurement of heat and has a contract size of 10,000 mmBTU or million BTU’s. Each tick of price movement in this contract is valued at $10 and there are 1000 ticks in a dollar of price movement. Thus, for every dollar move in natural gas the value of the contract appreciates or depreciates by $10,000. To illustrate, if the market rallies from 7.305 or $7.30 1/2 to 8.305 a trader would have made or lost $10,000 on one futures contract. This should be enough to deter you from this market, unless of course you have deep pockets.
This content is a glimpse into Carley Garners’ book “A Trader’s First Book on Commodities“.
***There is substantial risk in trading options and futures. It is not suitable for everyone.
Carley Garner is Senior Market Analyst and Broker with DeCarley Trading, and a columnist for Stocks and Commodities. The co-author of Commodity Options and author of the upcoming book, A Trader’s First Book on Commodities, Garner writes two widely-distributed e-newsletters, The Stock Index Report and The Bond Bulletin. She provides free trading education to investors at www.DeCarleyTrading.com. Garner is a Magna Cum Laude graduate of the University of Nevada Las Vegas.