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What is a Commodity Futures contract?
A commodity futures contract is an agreement to buy or sell a predetermined amount of a commodity at a specific price on a particular date in the future. Buyers use such contracts to avoid the risks associated with the price fluctuations of a futures' underlying product or raw material. Sellers use futures contracts to lock in guaranteed prices for their products.
How do Commodity Futures work?
If the price goes up, the buyer of the futures contract makes money. He gets the product at the lower, agreed-upon price and can now sell it at the today's higher market price. If the price goes down, the futures seller makes money. He can buy the commodity at today's lower market price and sell it to the futures buyer at the higher, agreed-upon price.
Of course, if commodities traders had to deliver the product, few people would do it. Instead, they can fulfill the contract by providing proof that the product is in the warehouse. They can also pay the cash difference, or give another contract at the market price.
