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santa123 07-29-2009 10:10 PM

Commodity trading - Pls share your experiences
 
Hello IVians,
As we all await our GCs, I thot we can explore some investment vehicles.

Does anyone here have experience with commodity trading?
Can we trade in commodities on H1 or L1 status?
Is it too risky like forex trading?
Who are the online brokers offer commodity trading?
Is there a minimum account balance / trade required every month or so?

Pls share your experience. Thanks!

smisachu 07-30-2009 01:01 AM

Dont even think about it unless you are a quant and have resources that can compete with the Hedge funds. Commodities do not behave like stocks, you need to be able to model prices using multi variate models. Then there is jumps. You should be familiar with jump diffusion/step functions etc. To be able to model these you will need to use a factor model like the Pilipovic model. Even then it will only be an approximation.

Commodities are purchased as futures. Futures are derivatives and you will need to hedge them. A perfect hedge for a future is 1:1 in the spot. Since there is no arb here you will have to use options. To model the price of an option you will have to be a master of Black-Scholes option pricing model or a similar method like monte carlo simulation. Even if you figure all this out you will have to delta hedge. Delta hedging commodity options is very expensive, you will bleed money. Look up Hodges-Nuberger model for delta hedging options on derivatives.

I suggest a book by Daragana Pilipovic called "Energy Risk", buy it and read it. After that if you still feel you can take on hundreds of computers running parallel with teams of quants modelling prices and programs trading algarithimic models; then Good luck!!

Trade stocks as modelling stocks is comparitively easy. Stocks have drift (mu). If you are saturated with stocks look into options and Fixed income. Leave all these complicated stuff to the pros. You have better chance of hitting a jackpot in a casino than making money in trading commodities.


Quote:

Originally Posted by santa123 (Post 567331)
Hello IVians,
As we all await our GCs, I thot we can explore some investment vehicles.

Does anyone here have experience with commodity trading?
Can we trade in commodities on H1 or L1 status?
Is it too risky like forex trading?
Who are the online brokers offer commodity trading?
Is there a minimum account balance / trade required every month or so?

Pls share your experience. Thanks!


reedandbamboo 07-30-2009 01:32 AM

I read this on an investing forum:

old saying in commodities:

"they take the staircase up and the elevator down"

puddonhead 07-30-2009 09:51 AM

Quote:

Originally Posted by santa123 (Post 567331)
Hello IVians,
As we all await our GCs, I thot we can explore some investment vehicles.

Does anyone here have experience with commodity trading?
Can we trade in commodities on H1 or L1 status?
Is it too risky like forex trading?
Who are the online brokers offer commodity trading?
Is there a minimum account balance / trade required every month or so?

Pls share your experience. Thanks!

Commodity trading is probably the most "fundamental driven" (as opposed to being driven by chartists) out of all trading activities I have seen. So theoretically, you are at the least disadvantage in commodities market against the big guys if you know your fundamentals right.

However, the very reason there is less technical trading in that market - lack of liquidity - again works against the average Joe. The most liquid of them - the Crude Oil future in Nymex - has a minimum lot size of 10,000 barrels - worth about $60k now. Any smaller sized derivatives (think of miNY futures etc) - come with significant liquidity or transaction cost penalties.

All in all, I personally think that a rational investor should prefer a market with the following criteria:
1. As much liquidity as possible. A liquid market will make stop loss the least painful. If you are a rational investor - stop loss is your lifeline.
Commodities market is not very liquid. The most liquid market in the world is FX - followed by equities.

2. As little special advantages for the big guys as possible.
The worst offender here is FX. Since these things are not traded in a listed exchanges - the big guys don't have to publish anything other than the bid and ask prices. Talk about a transparent price discovery. :confused: . Commodities market - specially the electricity market - used to have a lot of the opacity which benefited the big guys a few years ago. Some of the recent regulations have done away with much of this. I have personally worked on creating some of these so called "Chinese walls" mandated by new regulations.

That's all of my 2 cents. :)

thakurrajiv 07-30-2009 11:34 AM

Quote:

Originally Posted by smisachu (Post 568059)
Dont even think about it unless you are a quant and have resources that can compete with the Hedge funds. Commodities do not behave like stocks, you need to be able to model prices using multi variate models. Then there is jumps. You should be familiar with jump diffusion/step functions etc. To be able to model these you will need to use a factor model like the Pilipovic model. Even then it will only be an approximation.

Commodities are purchased as futures. Futures are derivatives and you will need to hedge them. A perfect hedge for a future is 1:1 in the spot. Since there is no arb here you will have to use options. To model the price of an option you will have to be a master of Black-Scholes option pricing model or a similar method like monte carlo simulation. Even if you figure all this out you will have to delta hedge. Delta hedging commodity options is very expensive, you will bleed money. Look up Hodges-Nuberger model for delta hedging options on derivatives.

I suggest a book by Daragana Pilipovic called "Energy Risk", buy it and read it. After that if you still feel you can take on hundreds of computers running parallel with teams of quants modelling prices and programs trading algarithimic models; then Good luck!!

Trade stocks as modelling stocks is comparitively easy. Stocks have drift (mu). If you are saturated with stocks look into options and Fixed income. Leave all these complicated stuff to the pros. You have better chance of hitting a jackpot in a casino than making money in trading commodities.

Wow, smisachu summarized the issue in 2 paragraphs !! Great post smisachu.
As smisachu pointed out for futures, forwards or options trading you will be going against the pros. Hedging is also not a static process, it is dynamic which means you need scale(lots of money) to trade. Unless you have lot of money and big heart for loss, it does not make sense to play in those markets. If you really want to try, try playing with options using optionsExpress or some other cheap trading website.
Now fundamental investing is different. Instead of directly playing with commodities you can play commodity stocks which are proxy for the commodity. The issue here is there are a few big players and bunch of small players. Small plays are too risky as most of them have resources outside US. You might be able to play big ones or medium sized ones. Have a look at companies like COP, EAC etc. You might be interested in looking at Canadian oil sands and trust plays.
Let me warn you about the volatility. As covered by smisachu, the pros can manipulate the prices in futures. Futures seem to be affecting spot a lot. Oil prices or any commodity can be very volatilile. So if you can't take 10% swings in days/hours, don't even think about commodity stocks !!
Personally I am long bull of oil and will stay like this in forseable future. I have interesting stories on my boom and bust experiences but that is a good beer talk :).

smisachu 07-30-2009 12:47 PM

You can trade commodities like stocks by taking a directional bet on long term price movement. But this is what you need to consider. Stocks always trade in Spot. If you buy MSFT you own shares of Microsoft today. Although single stock futures (SSF) are available now we will not look at derivatives right now.

Commodities are traded as futures. You can buy Soy futures today for December delivery or lean hogs for dec 2010 delivery.
Under conditions of No-Arbitrage the price of the future will be the price of the spot plus storage and delivery costs. If for example 3 month LSC (Light Sweet crude) is trading on NYMEX at $60; the cost of storage and delivery is say $20 for 3 months. Then 6 month LSC should be trading at $80. But if you look at the contract it might be trading at $55.

The reason being fundamentals. The peak driving season or the hurricane season is over and heating oil season is not yet on us or by looking at weather derivatives traders are factoring in milder winter. The leader of Iran has declared he will step down from office and retire to Hawaii, the rebels in Nigeria have turned themselves in and joined a church missionary..stuff like that.

So you might believe these fundamental assumptions or you might do your own research and say that the traders are wrong and they are discounting critical factors and the price should be more. So you can go long the future and hope for an increase in price and sell the future before delivery for a profit. This is the expensive route but you will never be wiped out for sure. Price of crude may drop but will never go to zero.

Or you trade options on the futures, for example:
Borrow money (leverage) buy the call; short delta units of the future contract and invest the proceeds at the risk free rate.
If you are correct the call will end up in the money, the shorted futures will loose value but since it is “delta” units it is only a portion of the position and the invested money will earn you the risk free rate. So you make some money on the call and loose some on the hedge and net you will profit. (Hopefully to cover the transaction costs and taxes)

If you are wrong (price falls) your call will expire worth less so you are wiped out there, your short will increase in value and you will still earn the risk free rate. So although net you will loose money it will not be as much as a naked call because of delta hedging.

This is explained in very very simple terms. Each transaction step will indicate modeling prices to know if the future is priced correctly, if the option is priced correctly and if the leverage you are getting is correct. Plus modeling future price movements and expected rate of returns and the most primary thing in any transaction the “Alpha”. Source of alpha should be very clearly defined. Let me go a bit deep and include some simple math:

E[R] = Alpha + betaR + epsalon

Where E[R] is the expected return-(see statists for more on expectation functions.)
alphais the excess return
betaR is market return or what the price of the commodity does in the duration chosen. (Market betais 1)
epsalonis error term or un explained return.

(Sorry the greek symbols did not display so I wrote words)

This is a kindergarten model of modeling your alpha. As there are many variables you will use a multi variant model to figure out return. Plus as I said in my previous post you have to model jumps. Jumps are spikes of very short duration which will only be seen in a log normal price distribution. A Gaussian distribution might not be changed much because of a spike of small duration. For example if you are trading electricity and the temperature in NJ hits 110 degrees, there is going to be a spike on that day for electricity prices but this will fall as soon as temperature falls.

And the core issue of all is you need to have access to products as indicated by puddonhead plus money and leverage capacity and risk bearing capacity. As you see this is not for the faint of heart or for some one to do part time. If you are really sophisticated and can do this with good resources, fine or else my advice is stick to stocks or stock derivatives. Hedge funds have teams of quants and super computers sitting and doing this every day. They will vacuum out even the slightest of alpha out there; they will simply take your money if you enter into a wrong trade. If someone is a quant and does this for a living then if his contract allows it or if his licensing allows it legally he can do it on the side but apart from it definitely not something the retail investor should indulge in. Just invest in some ETF like GLD or USO or some commodity mutual funds at the max.

Best of luck!!

johnwright03 07-30-2009 12:51 PM

Awesome
 
Wow...You seem to be a Guru in this field...!!! expert in the lingo too....

Quote:

Originally Posted by smisachu (Post 568059)
Dont even think about it unless you are a quant and have resources that can compete with the Hedge funds. Commodities do not behave like stocks, you need to be able to model prices using multi variate models. Then there is jumps. You should be familiar with jump diffusion/step functions etc. To be able to model these you will need to use a factor model like the Pilipovic model. Even then it will only be an approximation.

Commodities are purchased as futures. Futures are derivatives and you will need to hedge them. A perfect hedge for a future is 1:1 in the spot. Since there is no arb here you will have to use options. To model the price of an option you will have to be a master of Black-Scholes option pricing model or a similar method like monte carlo simulation. Even if you figure all this out you will have to delta hedge. Delta hedging commodity options is very expensive, you will bleed money. Look up Hodges-Nuberger model for delta hedging options on derivatives.

I suggest a book by Daragana Pilipovic called "Energy Risk", buy it and read it. After that if you still feel you can take on hundreds of computers running parallel with teams of quants modelling prices and programs trading algarithimic models; then Good luck!!

Trade stocks as modelling stocks is comparitively easy. Stocks have drift (mu). If you are saturated with stocks look into options and Fixed income. Leave all these complicated stuff to the pros. You have better chance of hitting a jackpot in a casino than making money in trading commodities.


thakurrajiv 07-30-2009 01:02 PM

Quote:

Originally Posted by smisachu (Post 571088)
You can trade commodities like stocks by taking a directional bet on long term price movement. But this is what you need to consider. Stocks always trade in Spot. If you buy MSFT you own shares of Microsoft today. Although single stock futures (SSF) are available now we will not look at derivatives right now.

Commodities are traded as futures. You can buy Soy futures today for December delivery or lean hogs for dec 2010 delivery.
Under conditions of No-Arbitrage the price of the future will be the price of the spot plus storage and delivery costs. If for example 3 month LSC (Light Sweet crude) is trading on NYMEX at $60; the cost of storage and delivery is say $20 for 3 months. Then 6 month LSC should be trading at $80. But if you look at the contract it might be trading at $55.

The reason being fundamentals. The peak driving season or the hurricane season is over and heating oil season is not yet on us or by looking at weather derivatives traders are factoring in milder winter. The leader of Iran has declared he will step down from office and retire to Hawaii, the rebels in Nigeria have turned themselves in and joined a church missionary..stuff like that.

So you might believe these fundamental assumptions or you might do your own research and say that the traders are wrong and they are discounting critical factors and the price should be more. So you can go long the future and hope for an increase in price and sell the future before delivery for a profit. This is the expensive route but you will never be wiped out for sure. Price of crude may drop but will never go to zero.

Or you trade options on the futures, for example:
Borrow money (leverage) buy the call; short delta units of the future contract and invest the proceeds at the risk free rate.
If you are correct the call will end up in the money, the shorted futures will loose value but since it is “delta” units it is only a portion of the position and the invested money will earn you the risk free rate. So you make some money on the call and loose some on the hedge and net you will profit. (Hopefully to cover the transaction costs and taxes)

If you are wrong (price falls) your call will expire worth less so you are wiped out there, your short will increase in value and you will still earn the risk free rate. So although net you will loose money it will not be as much as a naked call because of delta hedging.

This is explained in very very simple terms. Each transaction step will indicate modeling prices to know if the future is priced correctly, if the option is priced correctly and if the leverage you are getting is correct. Plus modeling future price movements and expected rate of returns and the most primary thing in any transaction the “Alpha”. Source of alpha should be very clearly defined. Let me go a bit deep and include some simple math:

E[R] = Alpha + betaR + epsalon

Where E[R] is the expected return-(see statists for more on expectation functions.)
alphais the excess return
betaR is market return or what the price of the commodity does in the duration chosen. (Market betais 1)
epsalonis error term or un explained return.

(Sorry the greek symbols did not display so I wrote words)

This is a kindergarten model of modeling your alpha. As there are many variables you will use a multi variant model to figure out return. Plus as I said in my previous post you have to model jumps. Jumps are spikes of very short duration which will only be seen in a log normal price distribution. A Gaussian distribution might not be changed much because of a spike of small duration. For example if you are trading electricity and the temperature in NJ hits 110 degrees, there is going to be a spike on that day for electricity prices but this will fall as soon as temperature falls.

And the core issue of all is you need to have access to products as indicated by puddonhead plus money and leverage capacity and risk bearing capacity. As you see this is not for the faint of heart or for some one to do part time. If you are really sophisticated and can do this with good resources, fine or else my advice is stick to stocks or stock derivatives. Hedge funds have teams of quants and super computers sitting and doing this every day. They will vacuum out even the slightest of alpha out there; they will simply take your money if you enter into a wrong trade. If someone is a quant and does this for a living then if his contract allows it or if his licensing allows it legally he can do it on the side but apart from it definitely not something the retail investor should indulge in. Just invest in some ETF like GLD or USO or some commodity mutual funds at the max.

Best of luck!!

Again a great post. Just want to comment that be careful with ETF's too. Most of the ETF's are not physical commodity holders. They play in futures and OTC swap markets.
I have looked hard to find ETF's or MF's fwhich are pure commodity holders e.g gold, silver etc.I still have not found good ones. The closest I could get was some portfolio of mix of real assets and futures. Most of the ETFs are again leveraged and kind of trap for average investors.
There are a few hedge funds or big funds which might offer pure plays but those tend to have huge entry investment requirement basically making them inaccessible to individual small investors.

vin13 07-30-2009 01:47 PM

Is this related to immigration?
 
There can be several things that we want to discuss and share. But isn't this platform supposed to be for immigration? If we start discussing about Best phone cards, airtickets to india, jokes, unrelated politics etc., we will soon loose the purpose of this website and forum.

If many senators, attorneys, other aides visit this website and can find all this unrelated posts, we loose the seriousness and focus we would like to address.

Maybe core team can evaluate and see if they want to create a special section for general discussion that does not show on the front page. Just a suggestion.

This is not an attack on any individual.

thanks

smisachu 07-30-2009 01:52 PM

LOL, Thanks but I am light years away from being a Guru. I am just a student (Shishya).

Commodities are not my strength I am better with Options, credit Derivatives and synthetic credit products but again nowhere as good as the really quant traders out there.

Quote:

Originally Posted by johnwright03 (Post 571134)
Wow...You seem to be a Guru in this field...!!! expert in the lingo too....


smisachu 07-30-2009 02:01 PM

I am not endorsing any fund or product. You have to do your own research and you have to figure out your own risk appetite- Disclaimer

Superfund is a hedge fund which has two funds of managed futures. Its enrty was $5K last time I checked. But again in a hedge fund you typically pay 2 & 20. That means 2% maintenance and 20% off the profits and there is huge down side risk where your entire investment can be wiped out. Tread carefully!!

Quote:

Originally Posted by thakurrajiv (Post 571182)
Again a great post. Just want to comment that be careful with ETF's too. Most of the ETF's are not physical commodity holders. They play in futures and OTC swap markets.
I have looked hard to find ETF's or MF's fwhich are pure commodity holders e.g gold, silver etc.I still have not found good ones. The closest I could get was some portfolio of mix of real assets and futures. Most of the ETFs are again leveraged and kind of trap for average investors.
There are a few hedge funds or big funds which might offer pure plays but those tend to have huge entry investment requirement basically making them inaccessible to individual small investors.


rksaigal 07-30-2009 02:11 PM

Share a thought
 
What would you recommend to enter this field on a long term basis and to supplement one's income?

maheshmail 07-30-2009 02:42 PM

for options trading...is there any site you will suggest which provides daily alerts???

thakurrajiv 07-30-2009 02:53 PM

Quote:

Originally Posted by sachug22 (Post 571227)
NYSE:GLD : SPDR Gold Trust holds physical gold
NYSE:SLV : iShares Silver Trust, the assets consist primarily of silver held by the custodian on behalf of the Trust.

SLV profile in yahoo mentions it tries to hold instruments to match SLV performance.
GLD claims physical gold holding in their profile. There is not holding detail on yahoo finance.
It will be interesting to dig into their actual portfolio holdings. But I agree that these are probably the closest instruments on gold and silver price play.

thakurrajiv 07-30-2009 02:57 PM

Quote:

Originally Posted by maheshmail (Post 571639)
for options trading...is there any site you will suggest which provides daily alerts???

I have optionsexpress account which is cheap way to trade in options. I have not looked into alert features.
You should be able to look up option prices from most of the electronic brokers. I have used tdameritrade and optionsexpress.


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