Commodities Explained / Commodity Foundations

Understand immediate transactions, future obligations and the different reasons participants enter a market.

Spot transactions and future delivery

A spot transaction generally concerns delivery or settlement in the near term under that market’s conventions. A futures contract is standardised and traded on an exchange, with specified quantity, quality and settlement terms. A forward is a privately negotiated agreement that can be tailored to its counterparties.

The word future does not make a contract a prediction service. Its price reflects what participants are willing to transact on under particular obligations and financing conditions.

Who uses the market?

Producers may want greater certainty about the prices they will receive. Commercial users may want to manage input costs. Merchants connect physical buyers and sellers. Speculators accept price risk in pursuit of a return. Market makers and arbitrageurs can help connect related prices and provide liquidity.

These roles can overlap. A company may hedge only part of its production and leave the remainder exposed. A position does not reveal a participant’s entire business or portfolio.

A bakery and a grower

Imagine a bakery planning purchases and a grower expecting a harvest. Each faces uncertainty, but in opposite directions. The bakery is concerned about rising wheat costs, while the grower is concerned about falling sale prices. A hedge can offset some of that risk without requiring them to agree on what prices will do.

The hedge still has to match the crop, quantity, timing and location closely enough to serve its purpose. A mismatch introduces risks covered later in this course.

Settlement is part of the product

Some futures can lead to physical delivery. Others settle in cash according to a defined reference. Many positions are closed before expiry, but that practice does not remove the contractual obligation if a position remains open.

Read the exchange and broker rules for expiry, delivery and account restrictions. Brokers may impose deadlines earlier than the exchange. An educational price chart does not provide those operational details.

Put it into practice

A futures price for delivery six months from now is above today’s spot price. Does this prove that the spot price will be higher in six months?

Check your answer

No. Storage, financing, availability, risk preferences and the contract’s terms can affect the difference. The eventual spot price remains uncertain.

Sources and further reading

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