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Commodity Futures - Definition
Commodity futures are futures contracts between two parties for the trading of a specific quantity of commodity products at a specific date and price.
Commodity Futures - Introduction
Commodity Futures are the oldest form of futures contracts in the world, both ancient and standardized modern versions. Today, commodity futures are traded in every major market around the world covering almost every conceivable commodity from live cattle to oil. Indeed, commodity futures are definitely one of the most important derivative instruments in the world today, contributing to stable commodity prices and a safe secure market for both producers and buyers.
This tutorial shall explore in depth what Commodity Futures are in futures trading, why trade commodity futures, the different kinds of commodity futures as well as how commodity futures came about.
What are Commodity Futures?
Commodity futures are a broad category of futures contracts that deal with the trading of futures contracts on different physical commodities. Indeed, futures contracts existed in the first place as agreements between buyers and producers to trade a certain product upon "harvest" at a fixed price. This makes commodity futures the oldest form of futures contract that ever existed.
The term "Commodity Futures" does not refer to a specific kind of futures contract but rather a broad category of futures contracts written on physical commodities. Any specific futures contract that deals with a physical product, such as Live Cattle Futures, are classified as "Commodity Futures". In fact, there are five main types of commodity futures; Grains Futures, Metal Futures, Energy Futures, Softs Futures and Livestock futures. Under each type of commodity futures, there are multiple specific futures contracts and markets. Commodity futures is truly a huge family of futures contracts and perhaps the largest of the two main category of futures contracts, the other being Financial Futures.
The list of commodity futures above merely lists the most popularly traded commodity futures markets in the US market. It is not an exhaustive list of all of the commodity futures markets available globally.
How To Trade Commodity Futures
First of all, you need to decide which exact commodity futures market you wish to get involve in. As you can see above, the commodity futures market is a huge one with many different specific commodities markets to choose from. Selection of a specific commodity futures market to trade in depends largely on your level of knowledge in a specific commodities market, your level of involvement and expertise in that particular industry and whether the characteristic behavior of a specific commodity futures market satisfies your trading objectives. Once a specific commodity futures market is decided, it is simply a matter of opening a futures trading account and then going through the steps in trading futures.
Types of Commodity Futures
As you can see in the picture above, there are five main classes of commodity futures; Grains Futures, Metal Futures, Energy Futures, Softs Futures and Livestock Futures. All commodity futures fall under one of these five classes and under each class, there are many different specific futures markets so lets take a look at each of these classes.
Grains futures are definitely the oldest form of commodity futures to ever exist. In fact, grains futures are the oldest form of futures contract to ever exist and has been used between farmers and buyers since ancient times. Grains futures deal with all kinds of grains with the most popularly traded ones being Corn Futures, Soybean Futures, Rice Futures, Oats Futures and Wheat Futures.
Metal futures are commodity futures that deal with the trading of precious metal such as gold, silver, copper, palladium and platinum. The most commonly traded metal futures are the gold and silver futures. There are even E-mini versions for both gold and silver futures. Due to the price volatility of precious metals, metal futures has always been a favorite form of commodity futures for short term speculators.
Energy Futures are commodity futures that deal with energy related products such as crude oil and heating oil. Indeed, energy futures is one class of futures contracts that gets reported in financial news every single day due to the tremendous impact energy prices has on daily life and the economy in general. Energy futures are also highly seasonal and can be extremely rewarding for futures traders who has a good knowledge of the seasonal trends of the industry. Most popular energy futures include Light Sweet Crude Futures, Brent Crude Futures, Heating Oil Futures, Unleaded Gasoline Futures and Natural Gas Futures.
Softs Futures are commodity futures that deal with agricultural products such as lumber, cotton and rubber. It is a little known futures market that rather hit the news. It is also an extremely unpredictable market with unexpected weathers creating all kinds of volatility in that market. Some of the most popularly traded Softs Futures include Cocoa Futures, Cotton Futures, Orange Juice Futures, Sugar Futures and Lumber Futures.
Livestock Futures are commodity futures that deal with the trading of live animal or live animal products. Livestock Futures is one class of commodity futures that professional futures traders tend to stay out of as it is relatively illiquid and easy to "corner" by the few big players in that market. Some of the most popular traded Livestock Futures are Live Cattle Futures, Lean Hog Futures, Feeder Cattle Futures and Pork Bellies Futures.
General Characteristics of Commodity Futures
Commodity Futures are typically "Physically Delivered" futures; This means that such commodity futures contracts will go into physical delivery whereby the long and the short trade the actual underlying asset upon expiration. However, there are also some commodity futures that comes with a "Cash Settled" contracts which will only end with the cash settlement of profits and losses between the long and short upon expiration but not the actual trading of the underlying asset. Even though cash settled commodity futures contracts greatly decreases the workload and responsibilities of futures exchanges it is still illegal for cash settled commodity futures to be offered on physical commodities in some countries.
Commodity Futures are generally very seasonal in behavior. This means that the prices of most commodities fluctuate on a predictable seasonal basis, making it easy for futures traders who understand these seasonal behaviors to profit from them reliably. An example of such seasonal price fluctuation would be the price increase of heating oil during winter season.
Apart from price speculation of a single commodity, commodity futures are useful for corporate hedging use through intercommodity spreads (read more about Futures Spreads). By sealing in the price of a raw material and the selling price of the eventual product, corporate producers can lock in their profits ahead of time instead of risking price fluctuations both at the raw materials as well as retail end. One such common intercommodity spreads is the Soybean/Soybean Meal spread where producers of soybean meal lock in the buying price of soybean and the selling price of soybean meal by going long on soybean futures and short on soybean meal futures, thereby guaranteeing their profit margin and hedging against price risk.
Almost every single commodity futures market display a different price behavior; Some commodity futures might typically display a backwardation market while some commodity futures might typically trade in a contango market. Some may display a normal market while some may display an inverted market. In this aspect, it is impossible to generalize the behavior of all of the different kinds of commodity futures. This is also why commodity futures traders tend to be extremely specialised in their particular market of choice and are also known by such; Crude Oil Futures Traders, Wheat Futures Traders etc.