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What is a commodity future contract?
It is an agreement in which the seller will sell a predetermined amount of commodities to the buyer on a particular date at a specific price. The main difference from future contract and option contracts is that holder in future contracts has obligation to act. Commodity contracts include assets like crude oil, gold, silver, wheat, corn, natural gas etc.
Advantages
The advantages of the commodity future contract are as follows −
Seller receives fixed sales price.
Since the buyers agree to take commodities at a particular rate, if there is any price drop, the seller does not lose.
Limited risk for sellers.
Better production plans.
Disadvantages
The disadvantages of the commodity future contract are as follows −
Fixed contract price.
Very risky in a highly volatile market.
Market speculations, world events, etc. will influence the prices.
Experts are required.
Now, let us learn about the advantages and disadvantages with regards to hedging a commodity.
Advantages
Fraction leveraged margin to total amount deposited (initially).
Can trade both sides (speculators, companies) of the market.
Can trade both sides (speculators, companies) of the market.
Disadvantages
Huge loss due to high degree of leverage.
Companies/producers may miss favourable prices.
Over hedges may lead to contract unwinding.
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