Commodities vs. Futures Contracts

Commodities and futures contracts are two terms you may have come across in your research into possible investment opportunities. In a nutshell, a commodity is the actual physical product. You can feel and touch a commodity. Examples of commodities include crude oil, corn and gold. A futures contract is, as the name implies, a contract of commodity trading. Each contract has a standard size. One contract of gold, for example, means you're controlling 100 ounces of gold because the standard gold futures contract size is 100 ounces.

Futures Contracts: A Confusing Name

The term "future" in the name confuses many people. It simply means that a commercial company wants to buy or sell a specific commodity at a later date in the future for today's agreed upon price. Futures contracts are typically for business and not individual speculators.

The Way a Futures Contract Works

Futures contracts are standardized including information about the commodity, date the commodity will be delivered, the amount to be delivered and the price of the commodity.

Going back to the gold example, let's say a mining company would like to sell 100 ounces of gold they have mined by a specific month. A jewelry make wants to buy 100 ounces of gold for a specific type of jewelry they'll be manufacturing the following month. Let's say the mining company wants to sell the gold mined by September and the jeweler needs the gold in October, but it's only April. Gold prices could move higher or lower during this time which is a risk for both the jeweler and the miner.

To benefit each company, a futures contract is created. A futures contact can be closed at anytime during market hours and fewer than 5 percent of these contracts are held until delivery.

More About Commodities

As mentioned earlier, a commodity is something you can feel and touch. The goods are usually produced by many different companies and/or sold by several different companies. Regardless of the number of companies that produce or sell the product, the quality is uniform so that it's impossible to tell the difference between a product from one company and the same product from another company.

In theory commodities are sold for their lowest cost of production, but usually the actual price is higher due to firm specific talents, barriers and other factors.

Fruit, vegetables, lumber, electricity and oil are all examples of commodities. Actual price can change if one company is more adept at creating a certain commodity, like bananas, than another company.