Look Toward the Future with Commodity Futures
The futures markets are the most direct way to get exposure to commodities. Futures contracts allow you to purchase an underlying commodity for an agreed-upon price in the future. Here are some ways you can play the futures markets.
Commodity indexes track a basket of commodity futures contracts. Each index uses a different methodology and performs differently than its peers. Commodity indexes are known as passive, long-only investments because they’re not actively managed and they can only buy the underlying commodity; they can’t short it.
You can choose from these five major commodity indexes:
Deutsche Bank Liquid Commodity Index (DBLCI)
Dow Jones–AIG Commodity Index (DJ-AIGCI)
Goldman Sachs Commodity Index (GSCI)
Reuters/Jefferies Commodity Research Bureau Index (R/J-CRBI)
Rogers International Commodity Index (RICI)
Futures commission merchant
Don’t be intimidated by the name — a futures commission merchant (FCM) is much like a regular stockbroker. However, instead of selling stocks, an FCM is licensed to sell futures contracts, options, and other derivatives to the public.
If you’re comfortable trading futures and options contracts, opening an account with an FCM gives you the most direct access to the commodity futures markets.
Commodity trading advisor
A commodity trading advisor (CTA) is an individual who manages accounts for clients who trade futures contracts. The CTA may provide advice on how to place your trades, but he may also manage your account on your behalf. Be sure to research the CTA’s track record and investment philosophy so that you know whether it squares with yours.
CTAs may manage accounts for more than one client. However, they’re not allowed to “pool” accounts and share all profits and losses among clients equally. (This is one of the main differences between a CTA and a CPO, discussed in the next section.)
Commodity pool operator
The commodity pool operator (CPO) acts a lot like a CTA, except that, instead of managing separate accounts, the CPO has the authority to “pool” all client funds in one account and trade them as if she were trading one account.
Investing through a CPO offers two advantages over investing through a CTA:
Because CPOs can pool funds, they have access to more funds to invest. This pooling provides both leverage and diversification opportunities that smaller accounts don’t offer. You can buy a lot more assets with $100,000 than with $10,000.
Most CPOs are structured as partnerships, which means that the only money you can lose is your principal. In the world of futures, this is pretty good because, due to margin and the use of leverage, you can end up owing a lot more than the principal if a trade goes sour.