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For an investor, hearing about options and futures contracts may be dizzying, but intriguing. Futures markets across the globe provide the means by which producers and processors can protect against adverse price movement in tangible goods, investors can implement risk management techniques for their stock portfolios, and speculators can come to help provide financial liquidity for all of them for the chance to profit from the rise and fall of prices. Investors wishing to diversify their portfolio have come to discover that the low, or even negative, correlation between stocks and bonds and commodities offers an opportunity to offset the adverse effects of inflation on their stocks with the seemingly opposite result in their commodity holdings.However, before we get ahead of ourselves, the first step is to make sure that the reader understands what commodities truly are. Commodities are tangible goods; raw products which are able to be held to a standard in order to be bought and sold by contract. Historically, commodities included mostly primary goods of value such as gold and coal and agricultural or food products like corn or livestock. In the modern sense, the definition of commodities has expanded to include certain debt instruments, like treasury bonds, newer fuels such as ethanol, and even weather conditions.The broad range of products that now have futures contracts which can be bought and sold on exchanges has opened up the possibilities for investors, providing a liquid market for adding diversity to any portfolio or a vehicle with which to manage portfolio risk. Trading commodity futures may not be for everyone and should certainly only be undertaken by those who understand the risks and have enough available risk capital. It is possible to lose all of your risk capital and more when trading futures and you should only undertake to trade these markets once you understand their form and function. With that in mind, what follows is our guide to the world of commodity futures trading and the things you will want to know to begin your venture.Since their formal inception at the Chicago Board of Trade, futures contracts have evolved to enjoy worldwide attention and have covered a wide array of products. The concept is a simple and efficient one. A futures contract is a standardized agreement between a buyer and seller to exchange the underlying commodity at the agreed price at the time of delivery. For example, a corn futures contract for the month of September will stipulate a quantity and quality of corn which must be delivered to a particular location in September. All corn contracts traded on the CBOT are for the same amount and grade. The only variables are price and delivery date.Most modern futures contracts traded on exchanges today assume a delivery point near the exchange, but for the largest group of traders - the speculators - delivery is not the intent. For them, the contracts will likely be offset prior to the first notice day, the first date at which delivery arrangements can be initiated. Simply put, the market is moving whether the investor is in it or not. The investor is simply trying to take advantage of the movement and take a piece out of the pie for themselves.Speculators are the life blood of modern markets. They are the traders who assume the risk associated with trading in an attempt to profit by buying or selling contracts during fluctuations in price. A speculator is there to take advantage of these price swings and their presence is what gives a market liquidity, increasing the available number of buyers and sellers on a given market. This same liquidity also allows them to offset their position prior to delivery.This group of commodity futures traders can be either individuals trading for the benefit of their own accounts, larger institutional buyers, or commodity pool operators. Larger funds and commercial accounts are characterized by their larger positions and holdings, and are normally held to specialized rules including requirements pertaining to the number of positions they hold and quantity limits. As you can imagine, larger purchases can be powerful market tools, and as such, some of these traders are held a little more accountable than others and other speculators will sometimes watch the participation of funds or commercial interest in a particular market as a means to try to portend direction.
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