Chapter 02 · Currencies, commodities, and government bonds
Commodity contracts
A commodity contract is a price on a physical thing, or on an index of physical things, standardised so it can be traded without inspecting the cargo. This chapter covers what the specification is doing, and why the price you see is not the price at a shop.
The specification is the product
A gold contract, a crude-oil contract, and a mentha-oil contract are not three flavours of the same trade. Each specification names the quality, the quantity in one lot, the expiry, the delivery location if delivery exists, and the currency. Two grades of the same metal can diverge because one is deliverable and the other is not, or because one is quoted in a different city. Before you compare a chart with a headline about ‘oil’, check that the headline is about the same grade and the same delivery month you are holding.
Spot, near month, and the cost of holding the thing
The futures price and the cash price differ by the cost of carrying the physical good — storage, insurance, financing — and by how badly someone needs the good now. A market that will pay extra to have the barrels today, rather than next month, can push the near contract above the later one. That is a fact about inventories and urgency. It is not, by itself, a forecast of next year’s price. If you hold a futures contract into the roll, you leave one expiry and enter another, and the two prices are not the same. The difference is a gain or a cost of staying in the trade. People who forget the roll describe it later as the commodity ‘not doing what the chart said’.
Who is hedging
A jeweller who has promised a necklace at a fixed rupee price, and has not yet bought the gold, is exposed to a rise in gold. Buying a gold future transfers that rise to the futures account, where it offsets the cost of the metal, and transfers a fall the other way. A farmer who will harvest in two months is exposed to a fall in the crop price and may sell a future. In both cases the future is doing a job only if the quantity, the grade, and the month are close to the real exposure. A contract on a different grade is a partial hedge plus a bet on the gap between grades.
An illustration with the roll left visible
| Price | What it means for someone who is long | |
|---|---|---|
| October contract, today | ₹62,000 a unit | The price of the promise you hold. |
| November contract, today | ₹62,450 | The price of the next promise, already including carry and expectations. |
| You roll: sell October, buy November | You pay the ₹450 difference | Staying exposed costs ₹450 before charges, even if your view has not changed. |
If your reason for being long lasts longer than the contract, the roll is part of the cost of the reason. Over a year of monthly rolls those differences add up, sometimes for you and sometimes against you. A chart of the ‘continuous’ price that hides the rolls will look smoother than the account you actually have.
What to remember
- Read the grade, the lot, the month, and the delivery terms. The noun ‘crude’ is not a specification.
- Futures and the shop price differ by carry, inventories, and which month you are looking at.
- Rolling into the next month is a second trade, at a different price.
- A hedge works to the extent the contract matches the physical exposure in quantity and grade.
- A continuous chart can hide the rolls your account will actually pay.