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University of Hong Kong Trading Workshop. Class 8 Commodities Workshop. David Lo. Agenda. 1. What is Commodity ? .CRB? 2. Correlation between commodities & other markets 3. Spot, Forward/Futures and Options Strategy on Commodities. 1. What is Commodity ?.

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University of Hong Kong

Trading Workshop

Class 8

Commodities Workshop

David Lo

  • 1.What is Commodity ? .CRB?
  • 2. Correlation between commodities & other markets
  • 3. Spot, Forward/Futures and Options Strategy on Commodities
1 what is commodity
1. What is Commodity ?

Commodities can be classified as follow :

1. Metals

2. Grains & Oilseeds

3. Meals, Livestock

4. Fibres & Timber

  • Softs & Tropicals
  • Energy
Over the last couple of years, CRB Price Index (a global benchmark for measuring commodity price movement) moves up by 34% in a year.
  • The price of commodities as diverse as crude gold, silver and oil make a series of new highs. This seminar will give you an overview of the current commodities market and their related derivative products, e.g. Gold/Oil futures and options, with the pricing models.
commodities outperform other markets
Commodities outperform other markets
  • With the current subprime crisis, commodities are outperforming equities and bonds markets.
  • Emerging markets still drive the demand for resources, no matter precious metals or agricultural products....
  • 26/Mar/2008
  • Gold =943.60 up 43% in a year
  • Silver = 18.00 up 35%
  • Crude Oil =102.40 up 63%
  • Rice = 19.36 up 99%
  • Corn = 550 up 41%
first energy metals and now agriculture
First Energy, metals and now agriculture…….
  • •Commodities and energy markets were seen as alternative assets investment in subprime crisis
  • •Cyclical play on global growth
  • •Trade on dollar weakness
  • •Hedge against inflation
  • •Way of leveraging Chinese and Indian growth, gold & silver demand, agricultural products...
  • •Estimated $170 billion from institutional investment have gone into Commodities in 2007 *
          • Source: * Jefferies
what is crb index
What is CRB Index?
  • Reuters/Jefferies CRB Excess Return Index
  • <.CRB> <0#.RJCRB>
history of crb index
History of CRB Index
  • The history of the Reuters/Jefferies-CRB Index dates back to 1957, when the Commodity Research Bureau constructed an index comprised of 28 commodities that made its inaugural appearance in the 1958 CRB Commodity Year Book.
  • Since then, as commodity markets have evolved, the Index has undergone periodic updates to remain a leading benchmark for the performance of commodities as an asset class.
  • The Index was renamed the Reuters/Jefferies-CRB Index in 2005 when it underwent its tenth and most recent revision - as the collaborative effort of Reuters, the global information company, and Jefferies Financial Products, LLC - to maintain its continued accurate representation of modern commodity markets.
1 5 4 constituents of example crb index
1.5.4 Constituents of, example, <.CRB> Index

<RJCRB01> & <RJCRB02> give information about the constituents.

<0#.RJCRB> shows all the constituents & pricing of each component.

u s dollar index usd 71 50 27mar2008
U.S. Dollar Index <=USD> 71.50 (27Mar2008)
  • A measure of the value of the U.S. dollar relative to majority of its most significant trading partners. This index is similar to other trade-weighted indexes, which also use the exchange rates from the same major currencies.
  • Currently, this index is calculated by factoring in the exchange rates of six major world currencies: the euro, Japanese yen, Canadian dollar, British pound, Swedish krona and Swiss franc. This index started in 1973 with a base of 100 and is relative to this base. This means that a value of 120 would suggest that the U.S. dollar experienced a 20% increase in value over the time period.
  • It is possible to incorporate futures or options strategies on the USDX. These financial products currently trade on the New York Board Of Trade.
Correlation Matrix Model .DJI .SPX .FTSE .GDAXI .N225 .HSI .HSCE .SSEC .BSESN .TWII (Stock Markets : 1Jan06 – 3Mar08)
Correlation : .CRB vs. Dollar Index, Discount Rate, Dow Jones Index, Hang Seng Index Period : 01Jan2006 – 03Mar2008
Correlation : .CRB vs. Dollar Index, Discount Rate, Dow Jones Index, Hang Seng Index Period : 01Jan2007 – 03Mar2008
Correlation between Commodities vs.
  • Dollar Index/Interest Rate/Stock Markets

Spot, Forwards/Futures & Options Strategy

crude oil gold
Crude Oil & Gold
  • Spot : WTC- & XAU= Period :1986-2008
the consumer years 1986 2006
The consumer years: 1986 - 2006
  • 1986 Price collapse $32 => $10
  • 1987 OPEC stop setting prices
  • 1990 Iraq invasion of Kuwait $20 => $40 => $20
  • 1998 Price collapse $20 => $10
  • 1999 Price recovery $10 => $30
  • 2003 Iraq war. Price surge, high volatility $25 => $45
  • 2004 Terrorism, world demand outstrips OPEC supply $50+
  • 2005 Hurricanes in the Gulf Coast $50 =>$70
  • 2006 Nuclear threat plus increasing demand $70+
  • Features
  • Trading taken over by large oil companies, trading houses and investment banks.
  • Free market with high volatility
  • Price management instruments are developed
crude oil markets
Crude oil markets
  • Physical Nigerian, Iranian,
  • Russian Urals, Columbian etc
  • Forwards BFO (Brent, Forties, Oseberg),
  • Dubai
  • Derivatives Futures NYMEX Crude Oil
  • Swaps WTI, Dubai......
price value units
Price value units
  • Oil supply, shipping, refining & trading expressed in US dollars
  • Crude oils: Worldwide $ per barrel
  • Products: Europe $ per metric ton

USA cents per American gallon

(but No.6 oil in $ / bbl)

Singapore $ per barrel (but fuel oil in $/mt)

Arab Gulf $ per barrel

(but naphtha & fuel oil in $/mt)

measurement and conversion
Measurement and conversion
  • Volume measured in barrels, gallons, cubic metres, litres
  • 1 barrell = 42 American gallons
  • Weight measured in metric tons (1000 kilograms)
  • Typical conversion factors bbls/metric ton
  • Nigerian Bonny Light 7.5
  • Arabian Heavy 7.1
  • Naphtha 9.0
  • Gasoline 8.6
  • Jet / kerosene 7.9
  • No.2 fuel / diesel 7.5
  • No.6 fuel / fuel oil 6.4
example crude oil future contract clc1
Example : Crude Oil future contract <CLc1>
  • A standard contract for purchase and sale of a standard quantity and quality of oil
  • Oil to be traded for delivery in a specified future month at specified locations
  • A standard number of months will always be available for trading and the last day of trading for each contract month will be defined
  • All trading takes place under the rules of a regulated futures exchange
relationships between cash and futures prices
Relationships between Cash and Futures Prices

Cash prices are the prices for which the commodity is sold at the

various market locations.

The Futures price represents the current market opinion of what

the commodity will be worth at some time in the future.

relationships between cash and futures prices32
Relationships between Cash and Futures Prices

Under normal circumstances of adequate supply, the price of the

physical commodity for future delivery will be approximately

equal to the present cash price, plus the amount it costs to carry

or store the commodity from the present to the month of

delivery. Futures = Spot + basis

These costs, known as carrying charges, determine the normal

premium of futures over cash.

carrying charges (cost of carry)








on contango
On Contango

As a result, one would ordinarily expect to see an upward trend

to the prices of distant contract months.

Such a market condition is known as contango and is typical of

many futures markets.

on backwardation
On Backwardation

The opposite of contango is backwardation, a market condition

where the nearby month trades at a higher price relative to the

outer months.

Such a price relationship usually indicates a tightness of supply;

a market can also be in backwardation when seasonal factors


measures of futures markets
Measures of futures markets
  • Open Interest
  • The number of open or outstanding contracts for which there has not yet been an offsetting sale or purchase
  • Volume
  • The number of contracts which change hands during a given period of time
premium received strategy buy 2 c 980 sell 1 p 940 sell 1p 920 490 received 31 1x2 38 2 28 9 x100
Premium Received Strategy : Buy 2 C(980)+ Sell 1 P(940)+ Sell 1P(920) = $490 (received) {(-31.1X2 + 38.2 + 28.9)X100}
  • An options strategy where the investor holds a position in both a call and put with different strike prices but with the same maturity and underlying asset. This option strategy is profitable only if there are large movements in the price of the underlying asset. This is a good strategy if you think there will be a large price movement in the near future but are unsure of which way that price movement will be.   The strategy involves buying an out-of-the-money call and an out-of-the-money put option. A strangle is generally less expensive than a straddle as the contracts are purchased out of the money.
  • Q1. Which Exchange trades Gold Future in 100 OZS lot size?
  • Ans : COMEX
  • Q2. Which Exchange trade Light Crude Future in 1000 BBL lot size?
  • Ans : NYMEX
  • Q3. Can you list the 6 base metals?