An Overview of the Commodity Futures Market

The Commodity Futures Market started in the 1840’s when Midwest farmers would come to Chicago to sell their wheat. Dealers would buy the wheat from the farmers and then ship it all over the country.

A central place was established where farmers and dealers could exchange cash for immediate delivery of wheat.

Eventually the Futures contract evolved when they began to commit to exchanges that would take place in the future. For example, a farmer and dealer would agree to the delivery of a certain quantity of wheat for a stated month and price in the future. This way the farmer knew how much he was getting for his wheat and the dealer knew how much it was going to cost in advance.

These contracts began to change hands before the date of delivery was due. If the farmer decided he didn’t want to deliver the wheat, he could transfer the contract to another farmer who did. If the dealer decided he didn’t want the wheat, he would sell the contract to another dealer.

Because the contracts state a fixed price for the wheat at a specific date, the value of the contracts would go up and down depending on the price movements for wheat. Dealers would trade futures contracts to hedge their risk against higher wheat prices.

Soon speculators, who had no intention of ever buying or selling the wheat, also began to trade the commodities contracts.

There are now a number of exchanges where many different commodity futures are traded. Examples of commodities are:

• Agricultural – Corn, oats, rice, wheat, sugar, coffee

• Livestock and Meat

• Energy – Crude oil, natural gas, propane, uranium

• Precious Metals – Gold, platinum, silver, palladium

• Industrial Metals – Copper, lead, zinc, tin, aluminum, nickel, steel

Very few transactions actually result in the delivery of the underlying commodity. The contracts are most often sold before they expire.

If you wish to trade futures contracts, you must open an account with a brokerage. If or when your contracts are nearing maturity, the brokerage company will inform you that you need to close your positions. Otherwise, you may end up having to take delivery of the underlying commodity or pay the full price of the contract. We can all relate to horror stories that we’ve heard in the past about a truck-load of coffee beans being dumped onto someone’s front lawn because for whatever unfortunate reason they had to take delivery of the actual commodity.

Go back to multiply money

Return to home page from commodity futures