Commodity Trading Guide

Physical versus paper

Physical trading moves cargoes between counterparties against contractual specifications, delivery windows and pricing periods. Paper trading transfers price risk through futures, swaps and options. Most trading houses run both: the physical book creates exposure, and the paper book shapes it.

Contract fundamentals

• Incoterms — FOB, CIF, CFR and DES allocate cost, risk and title transfer.
• Quality clauses — specification, tolerance and inspection regime.
• Pricing period — the assessment window and benchmark used to fix the price.
• Laycan — the window in which the vessel must present for loading.
• Demurrage — compensation for delay beyond agreed laytime.

Benchmarks

Physical trades typically price off an assessed benchmark plus or minus a differential: Brent and WTI in crude, published cargo assessments in refined products and fuel oil, exchange settlements in metals and agricultural markets. Differentials, not flat price, are where physical desks make or lose money.

Hedging

A physical position is normally hedged against the closest liquid instrument, leaving basis risk between the traded grade or location and the hedge. Managing that basis — grade, timing and location — is the core discipline of a commodity book.

Freight

Freight converts a location spread into an executable arbitrage. Vessel availability, bunker cost, canal and port constraints and demurrage exposure all determine whether an apparent arbitrage is real.

Trade finance

Cargoes are financed. Letters of credit, borrowing base facilities, prepayment structures and inventory financing determine how much volume a desk can carry. Credit capacity is a constraint on trading strategy, not a back-office detail.

Risk and compliance

Market, credit, operational and sanctions risk are managed continuously. Counterparty screening, vessel and ownership checks and sanctions compliance are now central to physical execution in energy and fuel oil markets.