Commodities

• Mined raw materials or agriculturally grown/bred produce.
• Includes processed products derived from these materials.
• Examples: Corn, soybean, palm oil, wheat, copper, gold.
• Broad Categories:
  • Grains and Oil Seeds (e.g., corn, soybean, wheat).
  • Energy (e.g., crude oil, natural gas, coal).
  • Industrial/Base Metals (e.g., copper, aluminum, tin).
  • Precious Metals (e.g., gold, silver, platinum).
  • Livestock (e.g., cattle, hogs, poultry).
  • Soft Commodities (e.g., coffee, sugar, cocoa).
• Trading started with bartering, then thrived with money, leading to exchanges like the Chicago Board of Trade (CBOT) and Chicago Mercantile Exchange (CME).

Commodity Futures Contracts

• A contract between two parties to buy and sell a specific commodity.
• Agreed quantity, price, and delivery date.
• Standardized Terms Include: Contract size, delivery/settlement terms, quality of underlying commodity, and contract months.
• Settlement: Commonly by physical delivery upon expiration.
• Most average futures traders do not opt for physical delivery unless they are commercial companies dealing with the physical commodity.

In Malaysia

• Commodity futures contracts are traded on Bursa Malaysia Derivatives.
• Examples of contracts traded:
  • Crude Palm oil
  • East Malaysia crude Palm oil
  • USD Crude Palm oil
  • Crude Palm kernel oil
  • USD RBD Palm Olein
  • Gold and USD tin.

Crude Palm Oil Futures (FCPO)

• Traded on Bursa Malaysia Derivatives.
• Global price benchmark for crude palm oil.
• Underlying commodity is the world's largest produced and exported edible oil.
• Most actively traded futures contract on Bursa Malaysia Derivatives.
• Denomination: Ringgit Malaysia (RM).
• Contract Size: 25 metric tons of crude palm oil per contract.
• Minimum Price Fluctuation: RM1 per metric ton (equals RM25 per contract).
• Settlement: Physically delivered to Port Tank Installations (PTI) at Butterworth, Port Klang, and Pasir Gudang.
• East Malaysia Crude Palm Oil Futures (FEPO): Identical to FCPO but with different delivery ports (Bintulu, Lahad Datu, Sandakan). Both FCPO and FEPO are physically settled.
• Trading Months: Spot month, next 11 succeeding months, then alternate months up to 36 months ahead.
• Most Active Month: The third contract month.
• Traders generally avoid the spot month to prevent physical delivery.
• Participants: Commercial hedgers, global fund managers, commodity trading advisors, proprietary traders, and individuals.
• Purpose: Offset risks of price movements (hedging) or express opinions on price direction (speculation).
• Trading Example:
  • Bullish: Buy a contract (e.g., at RM4000/metric ton) anticipating price increase. If price rises (e.g., to RM4300), sell to close the position.
  • Profit Example: RM300/metric ton profit (RM4300 - RM4000) results in RM7500 per contract (RM300 x 25 metric tons).
  • Bearish: Sell short, expecting prices to go lower, then buy back at a lower price.

Crude Palm Oil Price Drivers

• Key Drivers: Supply and demand.
• Factors Impacting Supply & Demand:
  • Weather:
    • Seasonal patterns (e.g., Malaysia's monsoon season: November-February) reduce production due to heavy rain/flooding, hampering harvesting.
    • Longer-term climate patterns (La Nina/El Nino) cause wet/dry spells affecting yields.
  • Manpower Availability: Shortage of labor affects productivity and supply.
  • Demand for Palm Oil:
    • Major importers: China, India, Europe.
    • Economic growth and food demand in India/China are important.
    • Import policies (tariffs, green energy, regulatory barriers) impact exports.
  • Price of Competing Vegetable Oils:
    • Supply/demand of soybean, sunflower, rapeseed, corn oils affect CPO prices.
    • Example: Drought in soybean-producing countries (US, Brazil, Argentina) lowers soybean production, increasing soybean oil prices, which can raise palm oil prices.
  • Crude Oil Prices & Biofuel Policy:
    • Higher fossil fuel prices increase biofuel demand (palm oil is biodiesel feedstock).
    • Government biodiesel mandates support palm oil prices.

Palm Oil Reports & Data Resources

• For Palm Oil Industry Data:
  • Malaysian Palm Oil Association (MPOA): Production estimates.
  • Malaysian Palm Oil Board (MPOB): Monthly data (production, stocks, exports, imports) released around the 10th.
  • Southern Peninsula Palm Oil Millers Association (SPPOMA): Production estimates.
  • ITS, Amspec, SGS: Cargo surveyors providing export estimates.
  • Reuters Poll & Bloomberg Poll: Supply and demand data.
• For Related Data:
  • US Department of Agriculture (USDA): Data for soybean and other vegetable oil crops.
  • US Energy Information Administration (EIA): Energy statistics and reports for crude oil/energy markets.
• Other Resources: Licensed Futures brokers (for weekly/monthly updates) and broker research reports.

Outright Trades (Comparison)

• Simplest strategy: Buy or sell futures based on individual views.
• Requires the market to move as anticipated to be profitable.
• Higher risk; for example, FCPO outright margin is RM7000.

Spread Trading

• Definition: Simultaneous purchase of one futures contract and sale of another.
• Involves both a long and a short futures contract simultaneously.
• Risk: Less risky than outright trades.
• Margin: Lower margins imposed by the exchange (e.g., FCPO calendar spread margin is RM1700 vs. RM7000 for outright).
• Profit: Price difference between the two contracts is more crucial than market direction.
  • For a buyer: Price difference should widen.
  • For a seller: Price difference should narrow or diminish.

Types of Spread Strategies

1. Intra-market (Calendar) Spread:

   • Simultaneous purchase of a futures contract in one month and selling the same contract in a different month.
   • Example: Buying February 2022 FCPO and simultaneously selling March FCPO.
   • Buyer expectation: Price difference to widen (e.g., from RM50 to RM60, profit RM10/metric ton).
   • Seller expectation: Price difference to narrow (e.g., from RM50 to RM40, profit RM10/metric ton).

2. Inter-market Spreads:

   • Simultaneous buying and selling of two different but related futures contracts, often on different exchanges or of the same commodity.
   • Example: FUPA-FCPO spread, which trades the relationship between USD-denominated FUPA and RM-denominated FCPO.

Benefits of Spread Strategies

• Minimized risks.
• Minimized volatility.
• Lower capital requirements.

A trader sold a February- March Crude Palm Oil Futures spread at a price the differential of RM 50 per metric ton. If the price difference narrows to RM40, what is the profit or loss for this spread position?

• Spread strategy: Trader sold Feb–Mar CPO spread at RM50 per metric ton.
• Later, the spread narrows to RM40.
• FCPO contract size = 25 metric tons

Understanding the Spread:

When you sell a spread, you are doing:

Short near month (Feb) and Long far month (Mar)

So, if the spread narrows (from RM50 → RM40), it means:

• Feb price fell relative to March (your short gained),
• or March rose relative to Feb (your long lost less). Since you sold the spread and the spread narrowed, this is a profit.

Price Change:

• Spread moved from RM50 → RM40
• That’s a 10 RM/ton gain
• Profit = 10 × 25 = RM250