In a primary sense, the simplified definition of a commodity is a thing of value, with uniform quality that is produced in significant quantities by multiple manufacturers. What defines the commodity is the contract and the underlying standard, not the quality inherent in the product. Also called futures exchanges, there are a variety of commodity contracts transacted daily in a number of standardized products, including equities, bonds, short-term rates, grains, softs and currencies.
The history of modern commodities trading began in Chicago, Illinois in the early 1800's. Chicago was a prime Midwest location for transportation, distribution and trading of agricultural produce.
In 1848, the world's first futures exchanged was formed, the Chicago Board of Trade (CBOT) and trading was initially in forward contracts.
A corporation or organization provides a futures exchange through a marketplace in which to trade derivatives such as futures contracts and options.
A commodities contract is a standardized contract that states the buy or sell price of an underlying instrument at a certain date in the future, at a specific price. This price is called the futures price and the date is called the delivery date or final settlement date. This type of contract gives the holder the obligation to buy or sell, and is different then an options contract, which gives the holder the right to buy or sell, not the obligation.
An option is a type of derivative contract that includes call options and put options, where the buyer pays the option premium to the writer. The buyer is said to have the long position, and the seller has the short position.
Exchange Traded Commodity Contracts
Exchange traded contracts are created when a contract is bought from another party and are not issued like securities. Compared with securities where an issuer issues the security, in exchange traded contracts clients do not know whom they have ultimately traded. The commodities contracts traded on the futures exchange are standardized, but to ensure liquidity there are only a number of standardized contracts.
Futures exchanges are regulated by the Financial Services Authority in the UK and in the US by the Commodity Futures Trading Commission. The world's largest commodity exchange is the New York Mercantile Exchange (NYMEX) and is located in New York City. Comprising this futures exchange is the New York Mercantile Exchange and the New York Commodities Exchange (COMEX).
When purchasing a commodity contract, clearing houses charge two types of margins, the Initial Margin and the Mark-To-Market Margin (Variation Margin). The Initial Margin is an amount of money, in the form of collateral, which is deposited by a company to the clearing corporation to cover possible future loss in the positions held by the firm. The margin account with the exchange is held by the client and money is added or subtracted from this account when they are daily swings in the value of the position. The margin account needs to be refilled if it gets too low. The Mark-To-Market Margin is a sum of money collected to offset the losses that may have occurred on the position of the firm. This margin is computed as the difference between the cost of the position held and the current market value of the position.