Futures trading involves an agreement between two parties to buy or sell an asset at a predetermined price on a future date. In this arrangement, one party commits to buying a specific commodity at a set price and date, while the counterparty agrees to sell the same commodity at the agreed-upon price and date. These contracts typically pertain to standardized commodities such as oil, gold, bonds, wheat, or stock indices and are traded on regulated commodity futures exchanges.
It’s important to distinguish between physically deliverable commodities like oil, wheat, and gold, and cash-settled contracts like index futures, which are converted into cash equivalents. The participants in futures trading generally fall into three categories:
- Producers: These individuals or businesses, ranging from small farmers to large corporate commodity manufacturers (e.g., gold miners), aim to sell their commodities on the market. To protect against price declines, they often engage in short selling futures contracts to secure a favorable selling price.
- Commercial buyers: These larger manufacturers purchase commodities to produce other goods. For instance, they might buy corn and wheat to manufacture cereal. Their objective is to hedge against price increases by buying futures contracts to secure a favorable buying price.
- Speculators: This diverse group includes retail day traders, as well as large hedge funds. Their focus is not on physical commodity transactions but rather on speculating and profiting from price movements. Speculators are the largest segment of market participants and provide liquidity to commodity markets.
Each participant in futures trading has distinct objectives, strategies, and time horizons for holding futures contracts. The combination of these different players creates the dynamic futures market, offering abundant opportunities for all involved.