Sharekhan Blog

What Is Commodity Futures?

  • Jan 31, 2024

Wondering, ‘What is commodity futures trading?’ Commodity futures trading is very important in the world's finance scene.giving investors a special way to protect against risks and guess what will happen with the prices of important goods in the future. So, let’s explore what commodity futures trading is, and how it works in the world of real-time commodity futures prices.

Commodity Futures Trading Defined

Trading in commodity futures is about purchasing and selling agreements that guarantee the delivery of a certain amount and quality of a commodity at an agreed price later on. These commodities vary widely, from farm goods such as wheat and soybeans to valuable metals like gold and silver. The main point of commodity futures is to predict how prices will move, and traders try to make money from these changes.

Objective

Investing in commodity futures serves the objective of shielding a commodity's price. Businesses utilize futures to secure prices for commodities they sell or use in manufacturing, aiming to hedge against potential losses from adverse price movements. Hedgers, such as farmers and manufacturers, employ futures contracts for this purpose.

Commodity futures, traded openly, accurately establish raw resource prices and forecast future commodity values. While influenced by daily news, commodity futures can sometimes reflect market emotions more than supply and demand. Speculators, reacting to crises, may inflate prices, creating bidding wars that don't alter the fundamental supply and demand dynamics, leading prices to normalize post-crisis.

Working Mechanism

Diverging from stocks, and commodity futures entails investors avoiding full upfront payments or ownership of the underlying asset. Rather, they commit an initial margin, a percentage of the contract value, to commence a futures position. The notional value of a commodity futures contract is derived by multiplying the underlying price with the contract size, representing deliverable units.

The considerable leverage stemming from the initial margin can magnify the influence of slight price shifts. Futures contracts adhere to a tick size, the exchange-prescribed minimum price increment, while the tick value indicates the real monetary gain or loss per contract with each tick movement.

Important Concepts

In futures commodity trading, key terminologies guide market participants. "Expiry" marks the end of a contract period, with different expiries in Indian Commodity Futures. "Spot price" reflects the commodity's cash market value, while "Future price" signifies the price of a Futures Contract. "Backwardation" occurs when the Futures' price is below the Spot price, while "Contango" is the opposite, with the Futures' price exceeding the Spot price.

"Margins" encompass Initial and Maintenance Margins, representing minimum amounts for opening and holding positions. "Settlement" denotes how a contract concludes, with cash and physical settlements being options, each involving profit or loss resolution through either cash exchange or physical commodity exchange.

Commodity Futures Traits

Derived from Commodity Forwards to streamline trade, Commodity Futures showcases unique traits. These encompass standardized contracts where exchanges dictate quantity, quality, price, and expiry time. A noteworthy feature is leverage, allowing traders to enter positions by paying only the initial margin, granting control over significant contract values.

Exchanges like MCX and NCDEX in India act as mediators in this well-organized market. Once overseen by the Forward Market Commission, commodity futures prices undergo monitoring for fair practices. Buyers have the option of physical delivery upon contract expiry, with an alternative to square off transactions before the tender period.

Real-Time Prices

In the quick-moving environment of commodity futures trading, having immediate access to real-time commodity futures prices is very important. These up-to-the-minute prices give traders and investors the information they need about how much commodities are worth right now, which helps them make quick decisions and carry out trades quickly. Real-time information is often crucial for taking advantage of opportunities and controlling risks well.

Dynamics of Commodity Futures

The process starts with a contract, which is an agreement to purchase or sell a certain amount of a commodity at a date in the future. People trading enter these contracts hoping that the market will shift in a direction that benefits them. A farmer growing wheat might use future contracts for commodities to set a price at which they will sell their crop, protecting themselves from possible drops in the prices.

Traders are busy buying and selling these contracts, so the market changes because of different things like political situations in countries, weather changes, and signs of how the economy is doing. Real-time commodity futures prices show these changes, which lets people change their plans to adjust their strategies in a better way. To do well in commodity futures trading, one must be very good at understanding how the market works and have access to real-time information.

The Role of Speculation and Risk Management

Some people trade in commodity futures for speculation, but others do it to manage risks. Producers and manufacturers, called hedgers, use these contracts as a way to guard against prices that change unfavourably. Speculators, however, seek to make money from the price changes rather than wanting to receive the physical commodity.

In Conclusion

Trading in commodity futures is an advanced financial activity that relies on forecasting and making a profit from future price changes. Real-time commodity futures prices act as the heartbeat of this market, providing traders with up-to-date information required to make knowledgeable choices.


Team Sharekhan
by Team Sharekhan

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