What is a Commodity Futures Contract?

A commodity futures contract is a contract to buy or sell a fixed amount of a particular commodity for a certain price on a specific date in the future. The commodity futures contract is used by producers and buyers of commodities to limit the impact of price fluctuations on commodities. Traders also buy and sell these contracts to speculate on price movement in the underlying commodities.

A commodity futures contract can be bought directly from a producer of a commodity. For example, if you wanted to purchase a contract on a certain amount of corn, you could enter into a contract with a corn farmer. Many buyers and sellers do this as a way to hedge against fluctuations in price.

The seller of a commodity wants to find a customer who is willing to purchase the commodity at a specific price in the future. The buyer of the commodity wants to lock in a reasonable price now even though he or she does not plan on taking possession of the commodity until a date in the future. This helps both parties get what they want out of this transaction. If the price of the commodity increases substantially before the product is delivered, it does not matter to either party because the price is locked in advance.

The other aspect of the commodities market is speculation. Many traders regularly buy and sell these contracts to speculate on the price of a commodity. A commodity futures contract can be bought or sold on an exchange just like buying or selling stock. One of the more popular exchanges to trade futures is on the Chicago Board of Trade. This allows a trader to work with a futures broker to buy and sell these contracts.

When purchasing a commodity futures contracts, a trader is hoping to benefit from a short-term price increase in the commodity. For example, if the trader agrees to buy a certain amount of corn for $.50 US Dollars (USD) and the price of corn increases to $.75 USD, the trader could make $.25 USD profit per unit. The trader never actually has to take physical delivery of the product to benefit from it. Instead, the trader has a contract that guarantees a purchase price at a certain date in the future. He or she can trade that commodity futures contract to someone else and make a profit.