Derivatives: Markets, Valuation, and Risk Management

CHAPTER 21

Commodity Products

Commodities are physical assets. Examples include precious metals, base metals, energy stores (e.g., crude oil and natural gas), refined products (e.g., heating oil and gasoline), and food (e.g., wheat, and livestock). Commodity derivatives have been traded in over-the-counter markets for centuries. The first modern-day commodity futures exchange began operation in 1865, when the Chicago Board of Trade launched trading of standardized futures contracts calling for the delivery of grain. Other futures exchanges were formed shortly thereafter—the New York Cotton Exchange in 1870 to trade cotton futures, the Chicago Produce Exchange (a forerunner to today's Chicago Mercantile Exchange) in 1874 to trade butter, eggs, and poultry, the London Corn Trade Association in 1878 to trade corn futures in England, and the Winnipeg Commodity Exchange in 1904 to trade oat futures contracts in Canada. With the passage of time, nonagricultural commodities were introduced—precious metal (silver) futures were launched by the Commodity Exchange in the United States in 1933, wool futures by the Sydney Futures Exchange in Australia in 1960, and livestock by the Chicago Mercantile Exchange in 1961. Crude oil and oil products were introduced next—heating oil by the New York Mercantile Exchange in October 1978, crude oil in March 1983, and unleaded gasoline in December 1984. Liquefied propane appeared in August 1987, and electricity in March 1996.

This chapter focuses on derivatives ...