Commodity

What are commodity futures?

Trading in commodity derivatives first started to protect farmers from the risk of the value of their crop going below the cost price of their produce. Derivative contracts were offered on various agricultural products like cotton, rice, coffee, wheat, pepper, etc.

commodity futures contract is a contractual agreement between two parties to buy or sell a specified quantity and quality of commodity at a certain time in future at a certain price agreed at the time of entering into the contract on the commodity exchange.

Expiry date for different contracts can vary from one contract to another. In commodity derivatives, a buyer and a seller agree upon a price where the buyer is obliged to buy the commodity and the seller is obliged to deliver the commodity on the pre - specified date and price.

Why trade in commodity futures?

Commodities are natural resources used in day to day life. Unlike financial futures; commodity futures do not carry the risk of investors going bankrupt or declaring losses. Commodities have upper and lower price bands. i.e. Beyond a certain price level commodity prices cannot fall as the producers will stop its production and commodity prices cannot raise beyond a certain price level as people will look for availability of substitutes.

Futures trading in commodities is transparent and facilitates fair price discovery on account of large scale participation of entities associated with different value chains and reflects views and expectations of wider section of people related to that commodity. This also provides effective platform for price risk management for all segments of players ranging from the producers, the traders, processors, exporters/importers and the end users of the commodity.

In commodity futures, it is necessary to distinguish between investment commodities and consumption commodities. An investment commodity is generally held for investment purposes whereas consumption commodities are held mainly for consumption purposes. Gold and Silver can be classified as investment commodities whereas oil and steel can be classified as consumption commodities.