- According to the U.S. Commodity Futures Trading Commission, "a futures contract is a legally binding agreement between two parties to buy or sell in the future, on a designated exchange, a specific quantity of a commodity at a specific price." Contracts trade on established exchanges such as the Chicago Board of Trade and the Commodities Exchange Center in New York.
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Some of the popular commodities for futures trading are: Treasury bonds, soy beans, corn, coffee, sugar, cocoa, orange juice, cattle, pork bellies, oil, gasoline, ethanol, natural gas, interest rates, currencies, market indexes, gold, silver and copper. This is just a partial list of futures contract commodities.
Futures contracts are sold by the producers of these commodities to lock in the prices of their future production. Contract buyers are users of the commodity protecting their future costs. Speculators buy or sell contracts on the belief the commodity spot price will vary significantly from the contract price. -
Each futures contract is for a specific amount of the underlying commodity. For example, the No. 11 Sugar contract is for the delivery of 112,000 pounds of raw sugar. If sugar for March 2010 delivery is trading for 22.5 cents per pound, as it was in early September 2009, the futures contract for March No. 11 Sugar is valued at $25,200.
Buyers of futures contracts only need to deposit or put up a small portion of the value of a futures contract. The margin requirement for each contract is set by the exchange where the futures trade. No. 11 Sugar contracts trading in September 2009 had an initial margin requirement of $2,520. -
You now have a futures contract that controls 112,000 pounds of raw sugar with an initial cost to you of $2,520. If sugar increases by 2 cents per pound, the value of your contract will increase by $2,240, an 89 percent profit.
Futures margin accounts have a maintenance margin requirement set by the commodities exchange. If the value of your sugar contract falls below the maintenance level you will be required to deposit more money, or the position will be sold out. The request for additional money is a "margin call." -
You cannot trade directly with the futures exchanges. You must open an account with a futures commission merchant. You may place orders or trades with an introducing broker, but all funds must be deposited with a futures commission merchant.
Individual futures accounts are either "non-discretionary," where transactions cannot be executed without your approval, or "discretionary," where you give permission to a third party to trade for your account. - An alternative way to invest in futures is through a commodity pool or managed futures fund. Commodity pools combine the funds of many investors to trade in the futures markets. They offer professional futures trading and eliminate the tasks of meeting margin requirements and margin calls.
