Commodity Contracts: Everything You Need to Know
Commodity contracts are contracts used for the buying and selling of commodities, which are items such as energy products, food, and metals.3 min read
2. How Do Commodity Contracts Work?
3. Investing in Commodities
Updated November 23, 2020:
Commodity contracts are contracts used for the buying and selling of commodities, which are items such as energy products, food, and metals.
What is a Commodity Futures Contract?
Commodity futures contracts are a type of contract used for selling a commodity. These contracts will include predetermined rules such as:
- The amount of the commodity that will be sold.
- At what price the commodity will be sold.
- The date the transaction will take place.
Essentially, a commodity futures contract is an agreement that a commodity will be delivered at a set date for a set price. Commodities cover three primary categories: Metals, energy, and food. Each commodity category can include several different items:
- Metal: Copper, gold, and silver.
- Energy: Gasoline and oil.
- Food: Meat, sugar, grains.
The reason buyers prefer commodity futures contracts is they can help protect the buyer from market fluctuations. Sellers also appreciate these contracts because they guarantee a specific price. These contracts can be used to outline a sale well in advance of when the sale will actually take place. For instance, some contracts are not completed for months or years after they have been written.
Speculators can also use these contracts to wager on the future price of raw material. Although this can be a very profitable endeavor, it can result in big losses, particularly for inexperienced traders.
How Do Commodity Contracts Work?
A futures contract will contain specific rules based on the type of commodity involved.
Some of the factors to consider in a futures contract include:
- The amount of the commodity.
- The specified delivery date.
- Price changes of the commodity.
If you want to buy or sell commodity futures, you will need an account with a future broker. Before you set up your account, you should be sure that your broker has completed National Futures Association registration. The Commodity Futures Trading Commission regulates the activities of futures brokers.
In general, a futures broker will focus solely on trading futures, meaning they would not also be involved in stock brokers. Once you have set up your account with a futures broker, you should receive the software that will allow you to trade on the futures market. Your broker should show you how to use this software and may help you with a trading strategy.
When you sign a trading futures contract, the current price of the commodity involved will be locked in. This means you will never have to pay more for the commodity than the price listed in the contract. Using these contracts can protect you against the falling or rising of a commodity's price.
If you want to trade one of your contracts, you will need to place a deposit for each futures contract that you want to trade. Margin deposit amounts are constantly changing, so you should research the current amounts before you try to trade a contract. Every type of commodity has a set amount that you must deposit when trading a futures contract. These deposit amounts are set on the exchanges for each commodity.
If a commodity's price goes up, the person who buys the contract will make a profit. A rise in price means the owner of the contract will receive the commodity at the price listed in the contract and then will be able to sell the commodity for the higher current price. On the other hand, if the commodity price drops, the futures contract owner will lose money because he will need to sell the commodity for a higher price than what was initially paid.
Investing in Commodities
If you're interested in investing in commodities futures, your best bet is putting your money into a community fund. You could either choose a mutual fund or an exchange-traded fund. The benefit of these funds is that they include a wide range of commodities, meaning you would benefit from rising prices on several different exchanges.
Because commodity futures trading is so complex and comes with inherent risks, this endeavor won't be for everyone. Prices on commodity markets are constantly fluctuating, and there is also a great deal of fraud in these markets. If you're not sure how or when to trade your contracts, you stand to lose a tremendous amount of money.
If you need help with commodity contracts, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.