To most people, futures trading might seem a fashionable idea, but in India, it goes back in time. In 1875 a cotton future exchange already existed! In the 1960s, though, futures in essential commodities were discontinued due to fears of speculative activity and hoarding. It was reintroduced in India, not until 2002.

What are commodity futures?

So, what is a futures contract? They are securities, the value of which is calculated by the underlying asset. It allows a purchaser or seller to buy or sell a commodity at a predetermined future price. Commodity futures are available for a wide variety of items such as wheat, cotton, coal, gold, silver, natural gas, etc.

Commodity futures thus help producers and purchasers hedge against price volatility. It goes without saying that producers, end-users, and traders are not the only parties that benefit. Speculators may also reap the benefits of price volatility and make money even though they do not have the least interest in the commodity itself.

Countries are also active in trading these futures, large petroleum importers, for example. Any market change affects their economies. They enter petroleum futures contracts for protection against this type of price volatility, which to some extent, mitigates the price risk.

Some of the futures trading basics a person should be aware of are –

• Exchanges: Commodity trading is very organised and occurs in commodity exchanges such as NYMEX in the United States and MCX and NCDEX in India.

• Regulated: Commodities markets get supervised to do certain fair practices. In India, the body that governs the commodity futures trading used to be the Forward Markets Commission. But this was merged with the Securities & Exchange Board of India (SEBI) in 2015.

• Leverage: You must deposit what is called an initial margin with the broker before you can trade in those futures. This represents a percentage of your exposure.

• Physical delivery: At the expiry of these contracts, customers have the option to accept physical delivery. When the customer does not request physical delivery, an alternative is available to square off the deal before its expiry date.

Benefits of commodity futures trading

Hedging: Such futures allow to hedge against market volatility, reducing uncertainty for manufacturers, traders, and end-users.

Benefits for investors: Investors benefit from investing because they can diversify their portfolios. For example, since gold prices move in many other assets in the opposite direction, investors can use gold futures to protect their bets and safeguard their portfolios.