Commodity Trading Guide

What physical traders are paid for

A physical commodity trader is paid for solving location, timing, quality and credit mismatches. The producer has volume at one place and time; the consumer needs a specification at another. Trading captures the spread between those positions net of freight, storage, financing and quality adjustment.

Flat price exposure is generally hedged out. What remains — and what determines profitability — is basis: the relationship between the physical grade at the physical location and the paper benchmark.

Contract structures

Incoterms allocate cost and risk transfer, and drive who controls freight and insurance.

• FOB — risk passes at load port; the buyer arranges and pays freight
• CIF and CFR — the seller arranges freight, with insurance included under CIF
• DES and DAP — delivered terms placing voyage risk on the seller
• Term contracts — recurring volume with a formula price and periodic review
• Spot cargoes — single-cargo deals priced against a dated benchmark window

Risk management

Serious trading operations separate the commercial desk from risk control. Positions are marked daily, exposure is reported by flat price, spread, basis, freight and currency, and limits are enforced independently of the desk.

• Price risk — hedged with futures, swaps and options against the benchmark
• Basis risk — the residual mismatch between the hedge and the physical grade or location
• Freight risk — hedged with forward freight agreements or fixed with time charters
• Credit and counterparty risk — managed with letters of credit, guarantees and limits
• Operational risk — demurrage, quality claims, documentation and sanctions screening

Freight and logistics

Freight is rarely a pass-through. Voyage economics, laytime, demurrage exposure and port restrictions determine whether an arbitrage that looks open on screen is actually executable, and cargo optimisation across a fleet is often where the real margin sits.

Trade finance

Physical trading is working-capital intensive. Transactional and borrowing-base facilities finance cargoes against the underlying goods and receivables, with banks taking security over documents of title and hedges. Access to competitively priced credit is as much a competitive advantage as market view.

Compliance

Sanctions screening, know-your-counterparty checks, anti-bribery controls and origin verification are now embedded in the trade lifecycle rather than a back-office afterthought. A compliance failure can be more costly than any market position.