Futures and Commodities Market | Definition & Explanation

Futures and Commodities Market

(First published on Commodities & Futures Guide.com) The futures and commodities markets are two vital parts of the investment world but represent two very different things altogether. Commodities markets are markets where raw or primary products are exchanged. These raw commodities are traded on regulated commodities exchanges, in which they are bought and sold in standardized contracts. The futures market is an auction market in which participants buy and sell future contracts for delivery on a specified future date. Trading is carried on through open yelling and hand signals in a trading pit.

A commodities market serves the purpose of allowing two individuals to exchange the rights to goods without visual inspection. Commodity markets require the existence of agreed standards opposed to spot markets where delivery either takes place immediately, or with a minimum lag and normally involves visual inspection of the commodity or a sample of the commodity. A forward contract is an agreement between two parties to exchange at some fixed future date a given quantity of a commodity for a price defined today (buy now, pay later). Forward contracts have evolved and have been standardized into what we know today as futures contracts.

A futures contract is a type of derivative instrument, or financial contract, in which two parties agree to transact a set of financial instruments or physical commodities for future delivery at a particular price. If you buy a futures contract, you are basically agreeing to buy something that a seller has not yet produced for a set price. But participating in the futures market does not necessarily mean that you will be responsible for receiving or delivering large inventories of physical commodities - remember, buyers and sellers in the futures market primarily enter into futures contracts to hedge risk or speculate rather than to exchange physical goods.

That is why futures are used as financial instruments by not only producers and consumers but also speculators. The futures market allows buyers and sellers an opportunity to manage price risks for goods they will either need to purchase or sell at a later date. An example is Boeing utilizing the futures market to hedge against an increase in the cost of aluminum at a later date which is a major component in the manufacture of an aircraft (i.e. hedging).Unlike a stock, which represents equity in a company and can be held for a long time, if not indefinitely, futures contracts have finite lives.

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