Introduction

An agreement to buy or sell a certain quantity of a commodity at a certain price on a certain future date is known as a commodity futures contract. Metals, oils, grains, and meats are all examples of commodities, as are monetary units and other financial instruments. Futures contracts can only be traded on the commodity exchange floor, with a few exceptions. Commodities can be divided into three categories: food, energy, and metals: meat, wheat, and sugar all top the charts as people's preferred food commodities. Oil and gasoline are the most common forms of future energy production. Gold, silver, and copper are only some examples of metals that have futures markets.

Futures contracts are used by consumers to lock in the price of essential goods, including food, energy, and metal. Because of it, they will be less likely to see a price increase. Commodity futures ensure sellers will be paid the agreed-upon price for their wares. They safeguard against price erosion. The prices of commodities often fluctuate, sometimes every day. The costs of contracts might also fluctuate. This is why we see a wide range in meat, gasoline, and even gold prices.

How a Commodity Futures Contract Works

At the expiration date, most commodity futures contracts are settled or netted. The spread between the opening and closing prices is paid in cash. A commodity futures contract will commonly be utilized to hedge a position in the underlying asset. Oil, grains, corn, precious metals, and natural gas are all examples of common assets. Futures contracts are valued not just by the current price of the underlying asset but also by other factors such as the length of time before delivery, interest rates, and storage fees.

Commodity futures traders often hold divergent expectations for the direction of underlying prices. If the underlying commodity's value has increased at the futures' expiration, the buyer will have made a gross profit, while if it has decreased, the buyer will have made a loss. But if the underlying asset's value drops at expiration, the seller will make a gross profit, and vice versa if the value rises.

How and When Are Commodity Futures Settled?

Futures are unlike other financial instruments in that they are settled every day. Exchange closing prices are established daily after the end of trading. The daily MTM price is standardized and applied uniformly to all parties involved. There are daily mark-to-market settlements until the contract expires or the position is closed.

The cash settlement for each day is the difference between the closing prices on days t-1 and t. If the outcome is negative, the contract holder's account will be debited, and the account will be credited if the outcome is positive. In the case of an increase in the contract's value at the daily settlement, for instance, a credit will be issued to the account of the long position holder, and a debit will be issued to the account of the short position holder.

How Futures Contracts Affect the Economy

Firms can secure a stable cost for commodities like oil by purchasing futures contracts. Farmers use them to guarantee a profit from selling their livestock or crops. The futures contract guarantees the ability to buy or sell the product at a predetermined price. According to the terms of the agreement, they intend to hand over possession of the goods. In addition, the agreement provides them with the means to calculate any associated revenues or expenditures. The contracts alleviate a great deal of danger for them. Hedge funds frequently use futures contracts to increase their purchasing power in the commodities market. They are not planning on selling anything. Instead, they want to purchase a compensating contract at a profitable price.

Typical Users of the Futures Markets

Commodity producers and consumers from commercial and institutional enterprises comprise most of the futures market participants. Many people take part in the futures market as "hedgers," to protect their wealth as much as possible from fluctuations in the market. Other players are "speculators," or people who try to make money off fluctuations in futures contract prices.

Regulation of Futures Professionals

The CFTC mandates that any business or individual dealing with customer funds or offering trading advice become a member of the National Futures Association (NFA), a self-regulatory organization. The Commodity Futures Trading Commission (CFTC) seeks consumers' best interests by mandating market risks and historical performance transparency.

Conclusion

Commodity futures contracts are standardized agreements that bind one party to buy or sell an underlying commodity at a specified future price and date. Futures contracts on commodities can be used to cover existing commodity investments. One can speculate on the future value of a commodity by using leverage to go long or short on a futures contract. Extreme leverage in commodity futures trading can magnify both profits and losses. A special form must be used to report profits or losses from commodity futures contracts to the IRS.