Commodity Futures

A Commodity Futures Contract is a legally binding agreement between a buyer and a seller to trade a specific quantity of a commodity (such as gold, silver, crude oil, natural gas, cotton, wheat, etc.) at a predetermined price on a future date.

Unlike options, both parties are obligated to fulfil the contract at the agreed price and date, regardless of the current market price of the commodity.

Key Features of Commodity Futures

1. Underlying Asset – The base commodity (precious metals, energy resources, agricultural products, industrial metals, etc.).
2. Standardization – Traded on exchanges (like MCX, NCDEX in India) in predefined lot sizes, quality standards, and delivery dates.
3. Obligation – Both buyer and seller must honour the contract at expiry.
4. Margin Requirement – Traders must deposit an initial margin with the broker/exchange to enter into a futures contract.
5. Settlement – Can be settled in two ways:
• Physical Delivery (actual delivery of the commodity)
• Cash Settlement (profit/loss adjusted in cash without physical delivery)

Example

Suppose you buy a Crude Oil Futures contract at ₹7,000 per barrel (lot size: 100 barrels) for delivery in October.

• If crude oil rises to ₹7,300 per barrel by expiry → Profit = (₹7,300 – ₹7,000) × 100 = ₹30,000.
• If crude oil falls to ₹6,800 per barrel → Loss = (₹7,000 – ₹6,800) × 100 = ₹20,000.

Both parties are obligated to settle, either by cash or physical delivery, depending on the contract terms.

Uses of Commodity Futures

1. Hedging – Farmers, producers, and traders use futures to protect themselves from price fluctuations (e.g., a farmer locks in wheat prices in advance).
2. Speculation – Traders use futures to profit from price movements with leverage.
3. Price Discovery – Futures markets help determine fair market prices based on expectations of demand and supply.