Definition: Commodity refers to goods such as oil, grain, cattle as well as precious metals and foreign currencies that are exchanged on the commodity exchange and the futures markets.
What Does Commodity Mean?
What is the definition of commodity? To be considered a commodity, a good must be standardized, usable upon delivery, and at a price that can create a market for the good. Also, it must meet the minimum standards of the exchange, which is commonly referred to as basis grade or contract grade.
Commodities trade on the futures markets such as the CME Group and ICE Futures, because the future contracts are standardized, thereby offering a price stability to the seller. Also, the buyer cannot abstain from the obligation to receive the quantity agreed on the contract at a specified price on a specified date. In this way, commodity trading protects both producers and buyers.
Let’s look at an example.
Example
Peter is a farmer who grows wheat. He decides to enter a futures contract that will expire in 6 months and buy a put option to sell 5 bushels of wheat for a price of $401.50 per bushel. If the price of wheat drops to $381.50 before maturity, Peter will exercise his put option to sell the 5 bushels at the agreed price of $401.50, thereby realizing a profit of $401.50 – $381.50 = $20 per bushel. On the other hand, if the price rises to $421.50, Peter will sell the 5 bushels in the open market for $421.50 per bushel to realize a profit of $20 per bushel.
The buyer that will enter the futures contract with Peter will be obliged to receive the 5 bushels for $401.50 after 6 months in the specified place of delivery. In that way, futures contracts protect both the farmer and the buyer and ensure that the prices will be fairly determined and will have the same value for all parties involved.
Summary Definition
Define Commodities: Commodity means a good that is homogenous and easily traded for other goods or currency.
