1. Fintech Chapter 11: Commodities

2. Commodity Futures Buy/Sell for future delivery Agriculture
Rice in China 6,000 years ago
Now electronic/HFT/asset diversification
Every major financial center
Chicago Board of Trade (CBOT) 1848

3. U.S. Commodity Exchanges
Chicago Board Options Exchange
Chicago Board of Trade
Chicago Mercantile Exchange
COMEX
ICE Futures
Kansas City Board of Trade
Minneapolis Grain Exchange
North American Derivatives Exchange
New York Mercantile Exchange
New York Board of Trade

4. Regulation
CFTC
Dodd Frank Act
SEF
Exchanges
FINRA/NFA

5. Commodity Markets Energy Agricultural Precious Metals Base Metals
Crude Oil
Gasoline
Heating Oil/Gasoil
Natural Gas
Electricity
Agricultural
Corn
Soybeans
Wheat
Coffee
Sugar
Cocoa
Orange Juice
Cattle
Hogs
Precious Metals
Gold
Silver
Platinum
Palladium
Base Metals
Copper
Aluminum

6. Exchange: Trading Conventions, Terminology
Crude Oil
Minimum price change $0.01
Contract size 1,000 bbls
Expiry months: F,G,H,J,K,M,N,Q,U,V,X, and Z
E.g. WTI crude oil for June 2020: CLM20
Opening and closing range/prices
Number of months/quarters/years to be listed for trading
Daily trading limits

7. Exchange: Rules and Requirements
Daily trading limits
Severe volatility: closing and reopening rules
Restrictions on position size
Set margin rules
Deliveries
Liquidations
Daily market reports:
Open and closing prices
Daily high and low
Trading volume
Open interest
Rulebook: participation/capitalization/trading/enforcement…

8. Market Participants Hedgers Portfolio Managers Individual Traders
Proprietary Trading Firms
Hedge Funds
Market Makers

9. Hedging Example: Farmers and Corn
Farmer must purchase supplies well in advance of selling crop
At risk to drop in price of crop ( supplies are fixed price, crop selling price is floating)
In April, futures price for Dec wheat is $4
$4 is profitable for farmer, so buy supplies, sell Dec futures, locking in sale price and profit.
When crop harvested in the fall, farmer sells wheat in cash market, buys back futures
Assume cash market price moves penny for penny with futures (“basis” is difference between cash and futures, assume its constant over the time period)
If futures price (and cash price) drops to $3.50, farmer gains $0.50 on futures ($4 sale, $3.50 buy back) just offsetting 0.50 loss in cash
If futures price (and cash price) rises, farmer loses $0.50 on futures, but gains offsetting $0.50 in cash.

10. Hedging Example: Airlines and Jet Fuel
Jet fuel major variable expense for airlines
Example: lock in jet fuel purchase price
In December, Sing Jet Kero price for June is $64 bbl
Trader wants to lock in price for 100,000 bbls
Buys 100 June swaps of 1,000 bbls each at $64
In June, trader sells swaps, buys cash jet fuel
If price has risen to $74, trader gains $10 on the swap, which just offsets $10 rise in cash price. Net purchase price is $64: $74 paid in cash market, less $10 gained on swaps
If price falls to $54, trader loses $10 on the swap. Net purchase price is still $64: Cash price has fallen to $54, but $10 gained on swap transacti0n.

11. Commodities as an Asset Class
Portfolio diversification lowers risk
Construct a commodity index with no or negative correlation with equities
S&P GSCI
2004: $36 billion
2008: $240 billion

12. S&P GSCI Reference Percentage Dollar Weight 2016 and 2017

14. Commodities ETF ETF: Exposure to commodity prices
Tax advantages
Liquidity
Convenience
Low costs
Over 150 different ETFs focused on one or a basket of commodities

15. Fintech in Commodities
Blockchain in Post Trade Processing
PTDL Working Group
Blockchain in Physical Commodities
Natixis/IBM/Trafigura
ING/SocGen/Mercuria: Easy Trading Connect
Artificial Intelligence in Energy Data Analysis
Kayros