Here is all you need to know about commodity futures

Commodity futures are distinctive financial tools that allow traders and investors to engage in the price fluctuations of fundamental raw materials, including agricultural goods, energy sources, metals, and various other resources.

In this blog, we will delve into the world of commodity futures. Let’s begin.

What are commodity futures?

Commodity futures are standardised contracts that obligate the buyer to purchase, and the seller to deliver, a specific quantity of a commodity at a predetermined price on a specified future date. These contracts provide a way for market participants to hedge against price fluctuations or speculate on the future price movements of various commodities.

Commodities available for trading are typically classified into distinct categories based on their inherent characteristics:

Hard commodities

• Precious metals: Gold, platinum, copper, and silver.
• Energy resources: Crude oil, natural gas, and gasoline.

Soft commodities

• Agricultural products: Soybeans, wheat, rice, coffee, corn, and salt.
• Livestock: Live cattle, pork, and feeder cattle.

How does a commodity futures contract work?

Commodity futures contracts typically conclude or offset their positions upon expiration, with the price difference between the initial trade and the closing trade. Commodity futures settle in cash. These contracts are commonly used for taking positions in underlying assets, presenting opportunities for both potential gains and substantial losses due to the significant price volatility of certain commodities.

Speculators employ commodity futures contracts to make bets on the future price movements of the underlying asset. These contracts allow investors to take either long (buy) or short (sell) positions in the commodity. 

Commodity futures example

Picture yourself as an oil producer. You know that in six months, you’ll have a lot of oil to sell, but you are worried the oil price might go down, hurting your profits. To protect yourself from this, you decide to use commodity futures contracts.

You use commodity futures to sell 1,000 barrels at $80 each. If the price drops to $70, you still sell at $80 and profit. Commodity futures fix your price, regardless of the market changes. Traders use them to speculate on price changes.

How can you begin trading commodity futures?

To get started in commodity options trading, consider the following step-by-step guide on how to trade commodity futures online:

• Step 1: Select an online commodity brokerage firm that aligns with your needs and preferences.
• Step 2: Complete the Know Your Customer (KYC) process, as required for account opening.
• Step 3: Fund your trading account with the necessary capital.
• Step 4: Create a well-thought-out trading strategy that matches your risk tolerance and financial objectives.
• Step 5: Once you have your plan in place, you can commence trading commodity futures. 

Commodity trading is done only in futures and options. Each commodity has its own lot size, which is the minimum quantity of a commodity that can be bought or sold. The tick size varies for different commodities. The upfront initial margin that you are required to pay when buying a commodity lot is 25% of the total contract value. 

Keep in mind that commodity futures and options trading can be intricate and risky due to the inherent volatility of commodity prices and potential fraudulent activities in the market. 

Why do future commodity markets matter?

• Price discovery: Futures markets provide valuable price discovery mechanisms for commodities, helping producers, consumers, and investors gauge future price trends.
• Risk management: Producers of commodities use futures contracts to hedge price changes. For example, a farmer can hedge against falling crop prices by selling grain futures.
• Investment diversification: Commodity futures offer investors diversification opportunities beyond traditional asset classes like stocks and bonds. 
• Economic indicators: Prices of commodities often serve as economic indicators. Changes in commodity futures prices can reflect shifts in supply, demand, and economic sentiment.
• Speculation: Traders and investors engage in commodity futures markets to speculate on price movements and potentially profit from their forecasts.

Conclusion

Commodity futures are a dynamic and essential component of the global financial system. Whether you’re a farmer looking to protect your crop’s value, an investor seeking portfolio diversification, or a trader aiming to profit from market trends, commodity futures offer a valuable avenue for achieving your financial goals in the ever-evolving world of commodities.

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