A commodity is a good that is demanded by the market like gold, petroleum, or common agricultural products such as grains, corn, and sugar. Commodity futures are contract agreements wherein a buyer and a seller agreed to exchange a specific commodity at a fixed price in a specified date in the future. There are two important factors in this type of transaction: first, the physical commodity already exists, and there is a possibility that the price of the good will increase in the future.
There are two reasons why this kind of trading flourishes:
On the buyer’s side, he/she is gambling with the price of the good. Of course, the buyer is expecting that the price of the good will rise in the future so he can earn from them. Because he is obligated to buy that good no matter what happens to the market, there is a risk that the buyer may end up owning unwanted or useless commodity. On the other hand, the price may go up as expected, so this will mean profits for the buying party.
On the seller’s side, this is to insure that he/she will earn specific revenue for the goods he/she is producing which might be affected with fluctuation of prices in the marketplace. Securing a specific future revenue make this trading process attractive for some sellers. If the price of the good dwindles in the specified future, the seller will never have to suffer losses. However, if the price dramatically goes up, the seller will never gain any additional revenue since he/she had already promised to deliver the goods in a fixed price. In that case, the buyer will have the advantage.
There are risks associated in this form of investment trading. Some people prefer to play it safer with commodity index funds. However, this is one of the most popular form of trading because the risks are quiet minimal compared to other forms of trading.
Related posts: