Futures Contracts on a Commodity

The purpose of this post is to provide the reader with a general information of futures contracts on a commodity. This discussion is not designed to be complete in all material respects. We render no opinion as to the validity of these concepts. Thus, the below information is being provided for educational purposes only. Nothing in this post should be considered as legal or investment advice regarding the contents hereof. If you have any questions relative to the information contained in this post, please contact a qualified attorney or investment professional.

A futures contract is a commitment to buy or sell a specified quantity of a commodity or financial instrument at a specified price during a particular delivery month. Once restricted largely to agricultural commodities and metals, futures contracts have in recent years been extended to include what are broadly termed financial futures — contracts on debt instruments, such as treasury bonds, Ginnie Mae certificates and on foreign currencies — and even more recently contracts on stock indexes.

The futures markets are basically divided into two categories of participants. Hedgers have owned the underlying commodity or instrument (such as a farmer of an agricultural commodity or an investor in the case of a financial or index future). Hedgers use futures to create countervailing position, thus protecting against loss due to price changes. Speculators do not own the underlying asset for commercial or investment purposes, but instead aim to capitalize on the ups and downs of the value of the contracts themselves. It is the speculators that provide the liquidity essential to the efficient operation of the futures markets. The speculators take the risk.

Speculators in futures contracts fall into three groups: (1) the exchange floor traders (scalpers), who make markets in contracts and turn small profits usually within the trading day; (2) spread traders, who hope to profit from offsetting positions in contracts having different maturities but the same underlying commodity or instrument, similar maturities but different underlying commodities, or similar contracts in different markets; and (3) position traders, who have the expertise and financial ability to analyze longer terms factors and ride out shorter term fluctuation in the expectation of unlit mate gains. However, as an average investor, please keep in mind that speculation in futures contracts is not recommended for you. The risk of loss is almost always to great, especially because of leverage.