Name: Exchange Traded Commodity Derivatives - SAP Broker Reconciliation for Commodity Derivatives
Uploaded: 2023-6-1
Duration: 404 s
Description: In Part Two of this series, you will understand what a commodity future and what a commodity option is. You will learn, what option exercising is and understand how a commodity trading process works.

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<div><div><div><div><div>In Part Two of this series, you will understand what a commodity future and what a commodity option is. You will learn, what option exercising is and understand how a commodity trading process works.<br><br></div></div></div></div></div>

Exchange Traded Commodity Derivatives - SAP Broker Reconciliation for Commodity Derivatives

Hello and welcome to another session about our SAP Broker Reconciliation for Commodity Derivatives app. I'm Simon Neumann and I'm a solution owner in agribusiness industry. In this unit, you will learn about commodity futures and options. Upfront, a short disclaimer. This topic is so huge and complex, you could write books about it. We just wanted to create a general understanding about commodity futures and options. Where do they come from and why are they needed? Let's start with Commodity Futures. Company Corn Trading, Inc. Buys 10,000 bushels of corn for delivery in the next harvest season in September from farmer Joe for a fixed price of $10 per bushel. As a trading company, Corn Trading Inc. Has the goal to sell the corn directly to, for example, a manufacturer, since they don't have a sign sale contract yet. And corn as a commodity is an exchange traded good. Currently in March They don't know the price for which they can sell it at a future date. Corn Trading Inc is exposed to the possibility of corn prices decreasing, also known as a price risk. If corn price today is at $10 per bushel, it can rise until the September delivery period, for example, up to $15 per bushel or go down to $5 per bushel. In one case, Corn Trading Inc will make a profit of $50,000. In the other one, a loss of $50,000. So the loss of $50,000 is the company's risk which they want to hedge. This is where commodity futures come into play to lower the financial risk of the company. While signing the contract with farmer Joe they fixed the price at $10 per bushel. This means they've both agreed on the current price, no matter what the price will be in September. If Corn Trading Inc wants to eliminate the risk, they have to place an order with their broker to sell a commodity future for the same quantity of 10,000 bushels for September. With this information, you can already see which details are needed to define a commodity future. In our example, there is the commodity corn, a due date or delivery date, September a quantity, 10,000 bushels and the trading price, $10 per bushel. There are some more specifics, but they are not important to understand the purpose of a commodity future in our case. But how is the company commodity future eliminating the company's risk if the price for the September corn future is at $10 per bushel. And Corn Trading Inc. Fixes the price with the farmer and orders the future. The company must pay $100,000 to the farmer for the quantity of 10,000 bushels in September. If the market price in September declines to $5 per bushel, the company still must pay $100,000 for 10,000 bushels of corn to the farmer, but can sell it only for $50,000 to their customers. To compensate for this potential loss from the physical trading, the moment Corn Trading Inc. sells the corn to a customer for the then prevailing market price, the company can buy futures for 10,000 bushels based on the relevant market price. In our example, this would be for $5 per bushel. Matching the bought and sold futures will realise the gains from the future transactions. Sold 10,000 bushels, September future for $10 per bushel and bought 10,000 bushels. September future for $5 per bushel will result in a gain from the future trading of $50,000 This will compensate for the loss Corn Trading Inc. encountered from the physical trading because of buying at $10 per bushel and selling at $5 per bushel. The second derivative we can reconcile in the app is the commodity option. If you have a general understanding of options, you might already guess what they can do. If not, you will learn it now. With an option deal, you either buy or sell the right to buy or sell a specific product during a specific time frame for a specific price, as this may be a bit too abstract. Here is an example. A commodity option always refers to a specific commodity future, like the September corn future from the example before. If you buy a commodity option, you buy the right to buy or sell this specific commodity future. Depending on if you're expecting the commodity future price to go up or down. If you're expected to rise, you will order a call commodity option for an underlying commodity future. Meaning you can buy it, otherwise you would order a put. If you're expecting a price go up, you will order a call commodity option. If our company Corn Trading Inc. Expects corn prices to rise, but they don't want to invest their money for a commodity future. They could buy a commodity option for a much smaller fee. The characteristics of a commodity option are the underlying commodity future, a due date, and a strike price. If the market price for the commodity future is above the strike price, the option is considered in the money and can be exercised. In our example above, instead of buying the future, Corn Trading Inc. buys an option with the strike price $10 per bushel. And waits until September when the price goes down to $5 per bushel. By executing the option, they can still buy the future with a price of $10 per bushel in September. To sum it up, you could say the commodity option is a kind of  insurance for the company. In reality, you have, of course, much more to consider when trading with commodity futures and options. But this video should give you a general overview and understanding of what commodity futures and options are and when you need them. Thanks for watching and see you next time.