Difference Between Commodity and Equity
The key difference between commodities and equity is that commodities are the undifferentiated product in which the investment is made by the investors and the commodity contracts have the fixed date of the expiry, whereas, the equity refers to the capital invested by the investors in order to acquire the ownership of the company and the contracts in the equity have no date of expiry.
Both are asset classes that are traded by investors across the world to generate profits or get a better return on investments. However, the difference lies in the way they are bought or sold primarily because of the inherent properties that characterize them.
What is a Commodity?
The commodityCommodityCommodity derivatives refer to those financial instruments that use the price or price volatility of the underlying commodities as the base for change in their price to amplify, hedge, or invert, in a way that the investors can track these underlying assets' performance. It includes commodity futures and commodity swaps.read more is not traded like physical holdings but is based on contracts for a particular duration of time. These contracts have some defined standards like future price, time duration, and quantity. An important point to note is that these trading positions are contracts that are valid only for a particular period of time. Beyond which they expire and are worthless.
For example, Gold futures 1-month contract trading at $ 100 will expire 1 month from now. Assuming the expiry date is 1st of next month, beyond this date, all open positions in the contract will close, and it will cease to exist from 2nd when a new contract for the next month starts trading on the exchange.
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What is Equity?
Equity is more like an investment where an investor is more interested in the long term horizon than the day to day movements in the short term and hence looking for a much better and less volatile returns. An equity holder is like an owner of the firm who has voting rights, share in profits, and also gains due to stock appreciation during the holding period. Equity investments are mainly listed firms like Infosys, TCS, Tata Motors, etc.
Commodity trading, on the other hand, can be on any commodity like consumption – gold, wheat, sugar, or non-consumption based like weather contracts. Irrespective of the type of commodity, the mechanism of trade is the same – through standard contracts valid for a particular duration that ceases to exist after the expiry date.
Commodity vs. Equity Infographics
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Key Differences Between Commodity and Equity
The key differences are as follows –
#1 – Nature of Product
- Commodity refers to a basic and undifferentiated product like corn, potato, sugar. They were introduced mainly for hedging and limiting losses from unexpected market movements due to unavoidable and unforeseen circumstances. For example, consider the case of a farmer who has cornfields. He is expecting his product (corn) to be ready for sale in three months. For our understanding, let’s assume the price of corn for a 3-month futures contract is trading at 500 per unit, and the current spot price is 400 per unit. The farmer can hedge its position using a 3-month futures contract and avoid any uncertainty arising because of any change in the demand-supply equilibrium like reduction in demand due to slowing growth or increase in supply due to less production, which might eventually affect the selling price. Hence commodity contract helps producers in limiting any downside riskDownside RiskDownside Risk is a statistical measure to calculate the loss in a security’s value due to variations in the market conditions. Also, it refers to the uncertainty level of realized returns being much lesser than the anticipated ones. read more arising because of any unavoidable circumstances.
- Equity, on the other hand, is basically ownership of a listed firm or a business. An investor might be influenced by a company’s growth and earning potential. He can invest in the firm by buying some equity (as per risk appetiteRisk AppetiteRisk appetite refers to the amount, rate, or percentage of risk that an individual or organization (as determined by the Board of Directors or management) is willing to accept in exchange for its plan, objectives, and innovation.read more), which will allow him to claim share on profits. Unlike commodity trading, there are not any contracts, and an investor can continue to hold the equity for as long as he wants to be provided, the company is still listed on stock exchanges. For example, an equity investor holding Infosys shares can continue to hold them as long as the company is solvent and is listed on stock exchanges. During this period investor has voting rights and claim to share in profits in the form of dividendsDividendsDividend is that portion of profit which is distributed to the shareholders of the company as the reward for their investment in the company and its distribution amount is decided by the board of the company and thereafter approved by the shareholders of the company.read more.
#2 – Mechanism of Trade
- Equity and commodity differ a lot in the mechanism of their trades. Commodity one can trade by taking positions on the short side or go long through futures in the listed exchange and forwards in the OTC marketOTC MarketOTC markets are the markets where trading of financial securities such as commodities, currencies, stocks, and other non-financial trading instruments takes place over the counter (instead of a recognized stock exchange), directly between the two parties involved, with or without the help of private securities dealers.read more. These contracts will be traded on a day to day basis, and hence the price will be dynamic based on the available information.
- Equity, on the other hand, is like an investment for longer periods of time. Here the investors are more interested in the stable returns not bounded by a time horizon, and hence there is no concept of the expiry date. Investors invest their money in equity by buying stocks and taking delivery. However, they can hedge their delivery positions through options and futures to weather short periods of high volatility.
Comparative Table
| Basis | Commodity | Equity |
|---|---|---|
| Nature of Product | Commodity refers to a basic and undifferentiated product on which traders can invest or take positions. | Equity refers to an investment or some form of capital that is invested into a firm or a listed entity to acquire ownership and share in profits. |
| Usefulness | These are short term trades used mainly for hedging to limit losses or making quick profits based on speculative bets. | These are mainly long term investments for gaining ownership and profit share for an emerging or growing business for long term sustenance. |
| Mechanism of trade | These are traded on commodity exchanges mainly through futures and options contracts. | These are traded on stock exchanges through various means like forwards and options contracts but mainly through delivery. |
| Time | Commodities are mainly traded through contracts. These contracts are priced based on future prices for a particular duration of time beyond which they expire and are worthless. | Equity remains listed on stock exchangesStock ExchangesStock exchange refers to a market that facilitates the buying and selling of listed securities such as public company stocks, exchange-traded funds, debt instruments, options, etc., as per the standard regulations and guidelines—for instance, NYSE and NASDAQ.read moreStock exchange refers to a market that facilitates the buying and selling of listed securities such as public company stocks, exchange-traded funds, debt instruments, options, etc., as per the standard regulations and guidelines—for instance, NYSE and NASDAQ.read moreStock exchange refers to a market that facilitates the buying and selling of listed securities such as public company stocks, exchange-traded funds, debt instruments, options, etc., as per the standard regulations and guidelines—for instance, NYSE and NASDAQ.read more for a long duration. The respective companies might go through economic cycles of expansion or recession, but their stocks might continue to list on the exchange. |
| Examples | Sugar, wheat, gold, silver, cotton, weather contracts | Listed firms like Infosys, Reliance, etc.; |
Conclusion
Both commodity and equity are different mechanisms by which investors are looking to generate profits and good returns on their investments. However, these asset classes differ in the mechanism they are traded. Since commodity contracts only allow one to take positions and does not grant any ownership in the underlying, they are mainly used by traders or speculators to make quick profits.
Equity, on the other hand, provides ownership without any time-bound contract or any liability and hence is popular among long term investors. In fact, it is perhaps the most popular asset class with stable, less volatile, and better returns for investors across the globe.
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