We’ve spend some time lately talking about commodities. Anyone who trades futures on the commodity markets ought to know a considerable amount about what they’re trading. But commodities are not futures.
- Commodities are a class of assets that includes energy, metals, agricultural products, natural gas and oil, and other natural resources. Commodities are natural resources, actual physical objects with an inherent value of their own.
- Futures are investment vehicles through which you invest in commodities. Futures can also be used to invest in other asset classes such as currencies, bonds, interest rates, stocks, indexes, etc. Futures have no value in and of themselves. They are known as derivatives because they derive (or take) their value from the underlying financial instrument (i.e., the commodity, currency, stock, etc.)
We use futures to invest in or trade commodities. In a futures contract, two parties agree to buy and sell the underlying asset (i.e., a physical commodity such as corn, wheat, oil, etc.) at a mutually agreed price at a specific time in the future. Most futures traders never intend to take physical possession of the commodity they are trading. In fact, of the billions of futures contracts traded on commodity futures exchanges every year, somewhat less than 2% result in the physical delivery of a commodity. Futures traders trade contracts back and forth to hedge or speculate on the price movement of the particular commodity that is the underlying asset of the futures contract. Their goal is not to own the commodity, but to make money on changes in the price of the contracts they are buying and selling.
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