Reviewed by Oct 05, 2020| Updated on
In other words, the investors trade a cash position on a particular commodity, for a futures contract on the same commodity. This type of exchange is useful for investors who wish to close their hedged positions.
In a futures market, traders can buy or sell a commodity or a financial instrument on a specified date in the future, and for a predetermined price. Such a contract is called a futures contract.
In the futures market, a transaction also known as options can take place, where the purchaser of the option has the right to sell the particular asset for an agreed price, at a later date.
There are several types of futures contracts. They include stock futures, currency futures, commodity futures, and index futures. Commodities include oil, precious metals, grains, livestock, energy, etc.
For example, let us take a commodity, gold. The futures contract is drafted to include the date on which the sale takes place, as well as the amount of money for sale. It will be the seller’s obligation to honour the terms of the contract on the specified date, and as per the terms agreed upon. The seller will need to undertake delivery to the purchaser.
In an against actual transaction, the delivery of gold will not take place. Instead, there will be a promise to deliver the gold at a future date, but even though the seller retains the gold, he will still receive the payment for the same.
On the other hand, the buyer buys the commodity, i.e. gold, at the current market rate, without physically receiving the commodity. He can then sell the contract at a profit, to another buyer, without needing to take possession of the commodity ever.