By Lee Lowell, futures options and commodities specialist*
Posted: Oct 10, 2008

Everywhere you look in the financial media right now, someone’s always talking about the "stock market woes", "increased volatility" and, of course, the "credit crunch".

But, while many investors curse the current volatility, it’s actually a key element of one market in particular -- the commodities market -- where some of the biggest fortunes are made through futures commodities and futures options. And, if you know where to look -- and how to actually use the commodities market’s volatility to your advantage -- you can also cash in on this "secret society".

Not many "ordinary" investors know this, but the commodities market can pack just as much wealth-building punch as the stock market -- if not more. But, because it doesn’t receive the same attention as stocks, the commodities world is often branded a "secret society", shrouded in mystery, with stories of people losing their homes or having 5,000 bushels of wheat dumped on their doorsteps.

But, this couldn’t be further from the truth. And, I’ll debunk those fables, bust myths and give you the scoop on the commodities markets -- and how to trade them profitably.

Now, let’s get to the basics...

Commodities and the Breakdown of Futures Commodities

Commodities are mostly physical products that we use everyday. That includes coffee, sugar, cocoa, orange juice, wheat, corn and even pork bellies. But, can you really trade these things and make money from them? You bet. And, contrary to some popular myths, it’s not that difficult to learn how.

Just as you can trade stock options, you can trade the above-mentioned commodities through regulated futures commodities and futures options contracts. You’re just speculating on the future direction of these commodities, then buying or selling futures commodities or futures options contracts to do it.

A futures commodity contract simply specifies that a certain amount of a commodity must be delivered to a certain location by a certain date. But, while there are players who will actually take or make the delivery of the physical products, we’ll never be doing that. We’re considered the "speculators" of the commodities markets. For us, futures commodities and futures options contracts are just a way to profit on the movements of commodity futures and options. There are two other groups besides us...

The Commodity Market Chain and Where We Fit In

• Hedgers: These are the farmers who grow the crops and sell them at harvest time. But, because they don’t know what price they’ll get, they need to lock in a certain price now. So, they sell a futures contract that guarantees them a specific price for their crops.
• End Users: These are the companies that make products out of the crops. For example, Kellogg’s uses corn and wheat to make breakfast cereals while Tropicana uses oranges to make juice. Because they need to lock in production costs in advance, they buy futures contracts and secure a buy price now instead of being at the mercy of the open market when they’re making their product.

Speculators like us fall in the middle. We’re there to provide bid and ask prices for other speculators, hedgers and end-users and profit ourselves. So, how are commodities used and priced and how do we access them?

Two Key Differences between Trading Futures Commodities versus Stocks

Just as you need to open a stock trading account to trade stocks, you need to open a commodity trading account. At present, stocks and commodities are regulated differently, and you can’t combine the two in the same account (although a few firms are moving toward that).

Once you have a broker, you’re free to trade. However, there are a few key differences between commodities and stocks.

• Expiration Dates: Unlike stocks, which you can hold forever, all futures commodities and futures options contracts have an expiration date. If you trade stock options, you’ll be familiar with this. But, whereas stock options expire on the third Friday of every month, futures options have varying expiration dates, which are commodity-specific.
• Point Multipliers: With stock options, each contract is equivalent to 100 shares of the underlying stock. But, with futures options, one option contract is equivalent to one futures contract. Also, futures commodities and futures options don’t all have the same point multiplier. Every commodity is different.

  For example, crude oil has a minimum price fluctuation of $10 per point with its options contracts while orange juice has a $1.50 point minimum price fluctuation. Corn, wheat and soybeans have a $6.25 minimum point value while coffee has a $3.75 per point minimum.

Don't rue stock volatility and curse market unpredictability. Commodities can bring a refreshing change...

The Commodities Market: 4 Reasons Why You Should Trade Commodities

The commodities sector is actually a very beneficial area of the financial marketplace to invest in -- and is a lot easier than stocks. Let me tell you why...

• Supply and Demand Economics = Predictability: The commodity markets tend to move in more predictable, smoother patterns, compared to stocks. That’s because their moves are based on supply and demand. For example, many food commodities move according to growing patterns, seasonal tendencies and weather. Prices are based on how well the crops are growing and how much supply is currently in storage. So, when predictable natural events such as hurricanes or droughts affect that situation, you can take advantage.
• Corporate-Less Commodities: Compared to stocks, commodities have no firms or CEOs running the markets, so the chances of corruption or number-fudging are greatly reduced. In addition, there are no volatile quarterly earnings reports to worry about.
• Fewer Outside Influences: We hear a lot about whether the Federal Reserve should stabilize volatility by cutting interest rates. No such debate in the commodities market, though. And, commodity investors don’t have to contend with a mass of misinformation and rumors in Internet chat rooms or what Jim Cramer is recommending on his TV show. How are you supposed to project a stock’s next move when you have all these outside factors jerking prices around?
• Mammoth Market Mitigates Risk: Although there are government reports to contend with in commodities, they typically only show how a commodity is progressing in the growing cycle. And, although you may read about a hedge fund trying to control a certain futures contract, the commodities market is so large that a hedge fund’s influence may only be short-term.

Investing in the Commodities Market: Hit the Exchanges and Branch Out

Lastly, take a look at the various commodity exchanges online. Just as stocks trade on the NYSE, NASDAQ and AMEX, commodities also trade on different exchanges. The four major ones are:

• The Chicago Board Of Trade (CBOT)
• The Chicago Mercantile Exchange (CME)
• The New York Board Of Trade (NYBOT)
• And the New York Mercantile Exchange (NYMEX), where I worked as a market maker on the trading floor for six years

You can find anything you want about the various futures commodities contracts by visiting the exchange websites. Plus, they offer a wealth of free information in the form of live and archived webinars.

In today’s rocky stock market climate, commodities represent a viable and profitable alternative to stock investing, allowing you to cut through the fluff and use volatility to your advantage. You may even find them easier to trade, just as I do.

*Reprinted (and modified) with permission from Mt. Vernon Research and www.smartprofitsreport.com. Lee Lowell is a futures options and commodities specialist at Smart Profits Report at www.smartprofitsreport.com. He is a contributing writer for several other publications with Mt. Vernon Research, including Xcelerated Profits Report and Triple-Zone Profit Trader.