What is a commodity future? It is when a buyer agrees to buy a certain commodity, such as wheat, at a set price from the seller at a future date. Why would anyone do that? Well, if the buyer thinks that the prices might go up from today's prices, they might try to "lock in" a lower rate by agreeing to the purchase in advance. They are also guaranteed the product and since they know the price, they can budget more accurately. The seller might believe that prices are going to go down because of too much of the commodity and not enough demand. So they would be happy to know that their commodity is already sold and they know the price.
Regardless of what the buyers and sellers believe, they have to come to an agreement. Supply and demand are what determines the prices. Occasionally a speculator may run a price up or down rather dramatically, but those prices don't last and the normal prices are set by supply and demand. The buyer and seller use the market prices on the date of the transaction. One way to compare a commodities futures market is to think of an auction. They're very similar. While usually people bid on an item in an orderly manner, sometimes there is a bidder who is there to run up the price. He doesn't really want the item, he just wants to push it just enough so that the seller gets more money but he doesn't have to buy it. That would be similar to a speculator. But ordinarily, the markets operate in an orderly fashion with the person being willing to pay the highest price buying the contract.
Options futures are less volatile than commodity trading directly. But it is still pretty risky. That is in large part due to the highly leveraged nature of the market. For example, suppose you win that contract to buy $10,000 worth of wheat in three months. You really hope that the market will continue to go up and you will be able to sell that wheat for $15,000. In the meantime though, you only had to put a down payment of $1,000 on that wheat. Maybe you're right and the market does continue to go up. You get to sell your wheat for $15,000. You just increased your net worth by $5,000. After all, with leverage you only paid $1,000 for that $10,000 of wheat and you sold it for $15,000, giving the original seller the $10,000 and keeping the $5,000.
But maybe you're wrong. Maybe there is a huge excess of wheat out there and you can't sell your wheat for any more than $5,000. So now you're stuck with paying $10,000 for wheat that's only worth $5,000. With leverage the gains can be huge but unfortunately the losses can be equally as impressive – just not in a good way.
If you want to get into commodity futures trading, do so slowly and try to find an expert to help you. Don't get cocky because you made a fortune on one trade. You can just as easily lose it on the next. Now that you know how to use commodity futures, start trading.
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