The use of derivatives in the commodity market

Secondary financial instruments have become more widespread due to the increased demand for various trading techniques.

One such instrument is derivatives, which are common for hedging assets in the commodity market. They are a kind of contract designed to stabilize the prices of tradable goods.

If the operations of selling and buying goods are not balanced, companies can incur losses due to the volatility of the exchange rate. To balance your personal finances, you can contact companies like Payday Depot for help in any situation.

Main types of derivative financial instruments

The derivatives market is constantly expanding, offering new options for secondary financial instruments. But some types are the most effective, and therefore most common.

Futures as a hedging tool

Futures are contracts between interested parties that guarantee the purchase or sale of a particular asset at a specified price in the future. Even if a change in the exchange rate leads to fluctuations in the prices of goods, thanks to futures, they can be traded at an agreed price. This type of derivatives is popular among:

  • Agricultural producers
  • Investors in the extraction and processing of raw materials
  • Mining companies
  • Dealers in precious metals

Individual agreements or forward contracts

Although forwards perform the same functions as futures, unlike the latter, forward contracts are not traded on centralized exchanges. This is their advantage and disadvantage at the same time:

  • The advantage is that they can be easily changed in terms of traded volume or delivery times.
  • The disadvantage is that they contain a higher risk of non-execution if one of the parties goes bankrupt. Since there is no regulator to execute forwards, they are not as guaranteed to be enforced as futures.

Options as a permissive contract

Unlike futures or forwards, which commit a trade to a specified price in the future, options give the buyer the right to buy or sell a specified asset at a specified price. And the obligation to sell the asset at this price is transferred to the seller.

If this price is not profitable for the buyer, he can refuse it without violating the contract. But so that the owner of the option does not hesitate for a long time in his choice, each option has its own expiration date, after which it becomes invalid.

Swaps or mutual obligations

Swaps are also OTC contracts and involve the exchange of financial obligations. In other words, this is a temporary exchange of some assets. Swap dealers play an important role in their conclusion and implementation. To make it, two cash flows are used:

  • One is fixed
  • The other changes according to the base interest rate

While swaps are not traded on exchanges, they can have multiple counterparties. 

Although initially the main purpose of derivatives was to balance the exchange rate of currencies when trading goods on the international market, their use is now much wider. Derivatives are often used to profit from short-term changes in their price.

Because of this, they have become so popular in recent years. Anyone who understands the principles of derivatives trading can also protect their shares from a decrease in value. Companies like Payday Depot will always protect anyone who has appeared in a difficult financial situation.