Commodity Market Participants: Hedgers, Speculators and Arbitrageurs

An efficient market for commodity futures requires a large number of market participants with diverse risk profiles. Ownership of the underlying commodity is not required for trading in commodity futures. The market participants simply need to deposit sufficient money with brokerage firms to cover the margin requirements. Market participants can be broadly divided into hedgers, speculators and arbitrageurs.

Hedgers :

They are generally the commercial producers and consumers of the traded commodities. They participate in the market to manage their spot market price risk. Commodity prices are volatile and their participation in the futures market allows them to hedge or protect themselves against the risk of losses from fluctuating prices. For e.g. a copper smelter will hedge by selling copper futures, since it is exposed to the risk of falling copper prices.

Speculators :

They are traders who speculate on the direction of the futures prices with the intention of making money. Thus, for the speculators, trading in commodity futures is an investment option. Most Speculators do not prefer to make or accept deliveries of the actual commodities; rather they liquidate their positions before the expiry date of the contract.

Arbitrageurs :

They are traders who buy and sell to make money on price differentials across different markets. Arbitrage involves simultaneous sale and purchase of the same commodities in different markets. Arbitrage keeps the prices in different markets in line with each other. Usually such transactions are risk free.

The market functions because of the differing risk profiles of the market participants. The fluctuation in commodity prices represents both, a risk and a potential for profit. The hedgers transfer this risk by foregoing the associated profit potential. The speculators assume this risk in the hope of realizing profits by predicting price movements. The arbitrageurs make the process of price discovery more efficient.

Once we understand what are the risks and returns involved for respective Commodity Market Participants, we can start investing in different commodity avenues.

In the next chapter we will learn about why commodity futures are good investment avenues along with it's advantages and different commodities traded in commodities market.

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