Physical
Commodity: a homogeneous (interchangeable) product.
Cost of Carry: “carry” refers to storage. Cost of carry includes physical storage and interest (opportunity cost).
Storage Cost: the cost of physical storage for a commodity.
Trading
Backwardation: the state of current (spot) prices being higher than prices that expire farther out into the future. Backwardation guarantees supply, since if prices were higher in the future than the present, suppliers would wait to produce and sell later at a higher price.
Contango: contango is the inverse of backwardation, whereas spot (current) prices are lower than future prices. As stated (directly above), contango is not an ideal state for markets.
Futures Spread: the difference between the spot price and the price of its futures contract.
Hedging: a risk management strategy used to offset potential losses or gains in the commodities market whereas organizations purchase options, short oil, or purchase futures contract to offset the inherent position of their business (see my other articles on hedging).
Speculation: The act of trading commodity futures to make money from price fluctuations. This differs from commercial traders, who trade to take delivery of or sell physical oil, or to hedge.
Margin: The capital (money) required to open and maintain a position in the futures market.
Leverage: using borrowed money to buy contracts.
Open Interest: The total number of futures contracts that have not been settled.
Long Position: a position where an investor profits if the underlying price rises.
Short Position: a position where an investor sells a commodity he or she does not own and buys it back for a profit if the price falls.
Clearing House: entities associated with exchanges that manage the confirmation, settlement, and delivery of transactions (think of the early banking days).
Mark-to-Market: The adjustment of an account, performed daily, to reflect profits and losses.
Prices
Spot Price: price for the immediate delivery of a good (the “current” price). The Spot Market is the market for spot prices. A Spot Contract is a futures or forward contract for delivery in the next month (regarded as “immediate” delivery since buyers have a month to take delivery).
Forward Price: the price for delivery at a specified future date, payable at the time of delivery. Price, quantity, and commodity specifications are determined in the contract.
Futures Price: futures prices are also prices for delivery at a specified future date, with terms similarly determined in futures contracts. Futures and forward prices differ in that futures prices are settled daily, meaning payments are made daily depending upon price movement between buyers and sellers.
Settlement Price: the market-clearing price for future contracts at the end of each trading day. E.g., the final price from the day before.
Cash Price: an average (weekly or monthly) transaction price for a commodity. Not equivalent to a spot price, which is more current.
Basis: The difference (spread) between the spot price of a commodity and the futures price (see contango vs. backwardation).
Liquidity: The degree of ease with which a commodity or a futures contract can be traded in the market. For example, outside the commodity market, a house is less liquid than, say, a few shares in a blue chip stock.
Volatility: Pace of change, e.g., a measure of the frequency and magnitude of price movements.
To learn more, consider reading about PADD Districts, the Why WTI and Brent are Crude Oils, and Why There are Price Differences Among Crude Oils, and my Oil & Gas Terms Guide.
Conceptual Credit: Robert Kaufmann
