A commodity derivative derives its value from an underlying asset which is necessarily a commodity. To understand the commodity derivatives markets it’s necessary to clear about ‘commodities’.

Commodities, in simple words are any goods that are common and unbranded. Gold, silver, rubber, pepper, jute, wheat, sugar, cotton etc., are some of the common commodities. For e.g. apple juice can be a commodity whereas the ‘Real’ apple juice cannot be called a commodity. You may be surprised to know that in the US commodities markets there are futures available even on cattle. Another feature of commodities is that they are commonly available.

Commodity markets represent the formal system for the interplay of demand for and supply of commodities. These markets can be broadly classified into spot market and futures market. Commodities for immediate delivery are traded through the spot market. The players in the spot market are the actual producers and the consumers of the commodities.

The other type of market called the ‘Futures market’ is for facilitating contracts for future delivery. (Please go through the material on ‘Futures and Options’ to understand about futures) These markets make available for trading, the various derivatives based on commodities. Usually traded ones are the futures and options. However in India options on commodities are not available and are expected to be introduced soon. The players in the futures markets are Hedgers, Arbitragers and investors.

Hedgers are those who hold simultaneous positions in the spot market also. These are generally the actual consumers or the producers of the commodities. For eg: A wheat farmer who expects his harvest to be over in 3 months time may sell a futures contract with an expiry of three months, so that even if the prices happen to fall after three months, he can still manage to sell at the price at which the contract was struck.
The large scale consumers of the products can also make use of the futures to secure their purchase. For eg: A cooldrinks can manufacturing company may buy tin futures, so that even if the prices happen to rise later, thy can be assured of the supply of raw materials at the pre-determined price.

The other major group of participants in the commodity futures market are the importers and the exporters. Since they have confirmed obligations to export/import fixed quantity of commodities at a particular period of time, they can take opposite positions in the futures market.

Arbitrage is a process of making profits using the price differences between two markets without exposing oneself to any risk. Arbitraging is a very profitable business. It is possible to arbitrage between two different futures markets or between the futures market and the spot market. However in an ‘efficient’ market arbitraging is not possible, because any price gap is closed immediately as soon the arbitragers enter the market.

Investors are those who participate in the market for profits and are ready to face the risk involved in the market. An investor can be anyone from an individual who has a small surplus income to the treasury desks of banks and corporate.
Most commonly traded derivatives around the world are futures, options and option futures. Some of the most popular commodity exchanges in the world are listed below:

London Metals Exchange, London
New York Mercantile Exchange, New York
Chicago Mercantile Exchange, Chicago
Chicago Board of Trade, Chicago
London International Financial Futures and Options Exchange (LIFFE), London
Tokyo Commodity Exchange, Tokyo
Winnipeg Commodity Exchange, Canada