What are Commodity Futures Contracts?
Commodity futures contracts are derivative, short-maturity claims on real assets. There are strategic and tactical opportunities that these derivatives present to informed investors. Commodity futures are also traded as standardized contracts on commodity exchanges, like the Chicago Board of Trade (CBOT).
This allows you to trade in a particular commodity at a pre-decided price and time. You may wish to trade contracts involving corn, wheat, rice, gold, silver, copper, or soybeans. Contracts in many commodities that are important in world trade and to the world economy are available.
Many commodities have pronounced price/volatility seasonality. Commodity futures are time-bound and perfectly hedgeable. If you are a commodity producer, and think that futures prices are way too high, you can sell your own product forward into the market. Commodity futures are still a relatively unknown asset class, despite being traded in the U.S. This may be because commodity futures are strikingly different from stocks, bonds, and other conventional assets.
Commodity futures are functioning effectively all across the world. However, like all efficient markets , markets for trading commodity futures also need to have capable regulators and well-established norms for trading. Commodity futures are different. They do not involve raising cash for a business’ operations; rather, commodity futures are like insurance for a business for the future value of their inputs/outputs. Commodity futures are highly speculative with markets often making large price swings. You should only use investment capital that you can afford to expose to such investment activity.
Commodity futures are for the most part no more or less volatile and risky than stocks. What makes large returns and losses possible is the use of leverage. Commodity futures are still a relatively unknown asset class. But the low transaction cost, frequent trading, good participation by traders and speculators and better dissemination of information will make the prices determined in the futures exchange, a better bet than the one decided by some sort of administered pricing mechanism. Commodity futures are positively correlated with inflation, unexpected inflation, and changes in expected inflation.
The trading and rediscounting of these instruments actually forms the bulk of the futures business. Commodity Futures are traded on special markets with Chicago being the town of choice. Futures trading isn’t the latest trend in the investment world; far from it.
Commodity Futures are exchange traded, legal contracts that are regulated in the US by the Commodity Futures Trading Commission (CFTC). Trading in commodities is a high risk activity that is mostly done by hedgers and speculators. Commodity futures are used to construct forecasts of the US dollar, which at horizons of around one year are more accurate than no-change forecasts. Commodity futures are standardized in terms of the quantity, quality , and delivery time for each commodity, except the price which is determined at the time the contract is entered into according to the demand and supply situation. In practice, physical delivery of the commodity rarely occurs because the delivery contracts are exchanged or closed out (traded out) before their expiration date.
Traders on the right side of the market with long positions when futures prices rise, or short positions when prices fall, profit, often quickly and handsomely. But the reverse is equally possible. Those on the wrong side of the market—with long positions when prices fall, or short positions when prices rise will suffer losses, often significant.
In trading commodity futures contracts the standard risk disclaimer often displayed on commodity brokers websites is entirely true. “Past performance is not indicative of future results. You should therefore carefully consider whether such trading is suitable for you in light of your financial condition. There is risk of loss in futures trading.”
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Tags: commodity broker, commodity futures contracts, commodity trader
