Commodity futures contracts are contracts to buy or sell a defined quantity of a commodity at a specific price on a future date. Metals, oil, grains, and animal products, as well as financial instruments and currencies, are examples of commodities. Futures contracts must be traded on the floor of a commodity exchange, with a few exceptions.
The Commodity Futures Trading Commission (CFTC) is a federal body that oversees the trading of commodity futures, options, and swaps. Anyone who trades futures with the public or gives futures trading advice must be registered with the National Futures Association (NFA), an independent regulator.
Check to see if the individual and firm are registered and if they have been subject to any disciplinary measures before investing in commodity futures. Use the NFA’s Background Affiliation Status Information Center to check your affiliation status (BASIC).
What is the difference between futures and commodities?
Commodities are physical products that may be bought or sold, such as oil, grain, or metals. Futures contracts are agreements to buy and sell goods in the future.
Investing directly in commodities
Purchasing various amounts of tangible raw materials and reselling them when the price is correct to generate a profit is the oldest and most direct approach to invest in commodities.
It is not a suitable approach for small investors unless the direct investment involves purchasing precious metals, which are easier to store and insure.
Another disadvantage of direct ownership is the high cost of transactions. For example, a gold dealer might mark up a coin by 2% or more while selling it, but then offer to buy it back at a lower price.
As a result, direct ownership is better suited to long-term investments where transaction costs can be reduced by executing fewer trades.
Investing in commodity futures
Individual investors who wish to make money in commodities might use commodity futures since they can own an item without taking ownership.
A commodities futures contract is an agreement to buy or sell a specific commodity at a predetermined price at a future date.
The process underlying futures contracts is straightforward: when commodity prices rise, the buyer of the futures contract receives a commensurate increase in the contract’s value, while the seller loses money. When the price of a futures contract falls, the seller profits at the expense of the buyer.
Are all futures contracts considered commodities?
At the contract’s expiration date, the seller of the futures contract assumes responsibility for providing and delivering the underlying commodity. For every commodity category, futures contracts are available. In the futures markets for commodities, there are typically two sorts of investors: commercial or institutional users of the commodities and speculative investors.
How do I go about purchasing goods?
Commodities, you’ve certainly heard, are a wonderful method to protect your portfolio against inflation while also providing variation from standard equities and bonds; but what exactly are commodities, and how can you invest in them?
Commodities are raw materials utilized in the manufacture of goods, and they are divided into two categories: hard and soft. Hard commodities (gold, silver, and platinum) are mined, whereas soft commodities are used (wheat, corn, coffee beans, etc.). Commodities can be purchased in three ways: as physical commodities, futures contracts, or through a mutual fund or ETF. A physical holding of gold coins is one example, while trading a futures contract is a more complex investing method. For most investors, however, a mutual fund or exchange-traded fund (ETF) is the best method to gain exposure to commodities.
Is it possible to make money trading commodities?
For some reason, ambitious novice traders believe that if they start trading commodity futures with $10,000, they will be able to live comfortably month after month. It’s feasible, but it’s quite unlikely.
Should I put money into commodities?
- Commodities can provide diversity, a hedge against inflation, and excess positive returns to investors.
- When an investor’s investments are tied to a single commodity or sector of the economy, they may face volatility.
- Commodity-based futures, stocks, ETFs, and mutual funds, as well as real commodities such as gold bullion, are available to investors.
- Oil, gold, and base metals are three of the most regularly traded commodities.
Commodities Futures
Buying and selling contracts on a futures exchange is the most common way to trade commodities. The way it works is that you engage into a contract with another investor depending on the price of a commodity in the future.
For example, you might commit to buy 10,000 barrels of oil at $45 a barrel in 30 days under a commodity future contract. You don’t transmit the physical items at the end of the contract; instead, you close it out by taking an opposing position on the spot trading market. When the futures contract expires, you would close the position by entering another contract to sell 10,000 barrels of oil at the current market price.
You will earn if the spot price is greater than your contract price of $45 per barrel, and you will lose money if it is lower. If you had entered a futures contract to sell oil, on the other hand, you would profit when the spot price fell and lose money when the spot price rose. You have the option to close out your position before the contract expires at any time.
To invest in futures trading, you’ll need to open an account with a speciality brokerage firm that specializes in these transactions.
“Traders who have an account with a brokerage business that offers futures and options can access these markets,” says Craig Turner, senior commodities broker at Daniels Trading in Chicago. Each time you start or end a position in commodity futures, you will owe a commission.
Physical Commodity Purchases
You are not purchasing or selling the physical commodity when you trade futures contracts. Futures traders do not take delivery of millions of barrels of oil or herds of live cattlefutures are solely based on price fluctuations. Individual investors, on the other hand, can and do take actual custody of precious metals like gold and silver, such as gold bars, coins, or jewelry.
These investments expose you to commodity gold, silver, and other precious metals while also allowing you to feel the weight of your money. However, transaction costs for precious metals are higher than for other assets.
“This method is only viable for commodities with a high value density, such as gold, silver, or platinum. “Even then, investors will pay huge markups on the retail market over spot prices,” Giannotto warns.
Commodities Stocks
Another alternative is to purchase the stock of a commodity-related company. If you want to invest in oil, you could buy stock in an oil refining or drilling company; if you want to invest in grain, you could buy stock in a huge agriculture company or one that distributes seeds.
The price of the underlying commodity is tracked by these types of stock investments. If oil prices rise, an oil company should become more profitable, causing its stock price to rise as well.
Because you aren’t wagering on the commodity price, investing in commodity stocks is less risky than investing directly in commodities. Even if the commodity’s value falls, a well-run business can still make money. However, this is true in both directions. While increased oil prices may improve an oil company’s stock price, other factors such as management and overall market share also have a role. If you’re searching for an investment that closely matches the price of a commodity, buying stocks isn’t the best option.
Commodities ETFs, Mutual Funds and ETNs
Commodity-based mutual funds, exchange-traded funds (ETFs), and exchange-traded notes (ETNs) are also available. These funds pool money from a large number of small investors to create a huge portfolio that attempts to track the price of a commodity or a basket of commoditiesfor example, an energy mutual fund that invests in a variety of energy commodities. The fund may purchase futures contracts to monitor the price, or it may invest in the stock of various commodity-exposed companies.
“Commodity ETFs have genuinely democratized commodities trading for all investors,” adds Giannotto. “They are low priced, easily accessible, and very liquid.”
You can acquire access to a much wider choice of commodities with a minimal investment than if you tried to establish your own portfolio. Plus, the portfolio will be managed by a professional investor. However, you’ll have to pay the commodity fund a higher management charge than you would if you made the investments yourself. Furthermore, depending on the fund’s strategy, the commodity price may not be accurately tracked.
Commodity Pools and Managed Futures
Private funds that invest in commodities include commodity pools and managed futures. They’re similar to mutual funds, except that many of them aren’t publicly traded, so you have to get permission to invest in them.
These funds can employ more advanced trading methods than ETFs and mutual funds, resulting in larger returns. In exchange, managerial costs may be increased.
Commodity vs Stock Trading
Leverage is far more widespread in commodity dealing than in stock trading. This means you only put down a portion of the investment’s total cost. Instead of putting down the entire $75,000 for the full value of an oil futures contract, you might put down 10%, or $7,500.
According to the contract, you must maintain a minimum balance based on the estimated value of the trade. If the market price begins to move in a direction where you are more likely to lose money, you will be subject to a margin call and will be asked to deposit additional funds to bring the trade back to the required minimum value.
“Trading on margin can result in higher profits than the stock market, but due to the leverage used, it can also result in higher losses,” Turner explains. Small price changes can have a large impact on your investment return, so there’s a lot of room for profit in the commodity market, but there’s also a lot of room for loss.
Commodities are also a short-term investment, particularly if you enter a futures contract with a specified expiration date. This is in contrast to stocks and other market assets, where it is more typical to buy and hold assets for a long time.
Furthermore, because commodities markets are open nearly 24 hours a day, you have greater time to make deals. When trading stocks, you should do so during regular business hours, when the stock exchanges are open. Although premarket futures provide some early access, most stock trading takes place during regular business hours.
Overall, commodity trading is riskier and more speculative than stock trading, but it can also result in faster and higher rewards if your positions succeed.
For instance, how do futures work?
Corn growers, for example, can utilize futures to lock in a price for selling their harvest. They limit their risk and ensure that they will obtain the agreed-upon price. If the price of corn fell, the farmer would profit from the hedge, which would compensate for losses from selling corn at the market. Hedging efficiently locks in an appropriate market price with such a gain and loss offsetting each other.