What Is a Cash Contract?
A cash contract is a financial arrangement that requires the delivery of a particular amount of a specified commodity on a predetermined date. A cash contract is closely related to, but should not be confused with, a futures contract where trading positions are usually closed out in cash prior to delivery of the commodity. Futures traders are often hedging or speculating on price movements to manage risk or turn a profit, and are not actually interested in physically owning the commodities.
Understanding Cash Contract
There are other important differences between cash contracts and futures contracts. A cash contract creates a direct obligation between the buyer and the seller, whereas a futures contract obliges each party to an exchange's clearinghouse. In this sense, a cash contract is much closer to a forward contract, which is a customized contract between two parties to buy or sell an asset at a specified price on a future date. Also, a cash contract can be drawn up for any amount that a buyer and seller can agree on, whereas a futures contract must be written for a predetermined, standardized quantity and quality allowed by the exchange.
Cash Contracts for Deliverable Commodities
Cash contracts convey important information regarding current market transactions. For example, cash contracts specify the quantity and the amount paid for commodities on the spot market, where large manufacturers commonly purchase the commodities they need for production in their factories. These manufacturers are not speculating on the price of the commodities they need, which can be done in the futures market. Instead, they are physically purchasing the raw materials they need for their manufacturing process. Commodities are physical products that are generally indistinguishable no matter which company brings them to the marketplace. Examples include corn, crude oil, gasoline, gold, cotton, beef, and sugar.
Cash Contracts Are Highly Customizable
There are many different ways to trade commodities and financial instruments. The most popular way is between banks themselves in a practice called "over-the-counter" (OTC) trading because the transaction occurs between the institutions directly and not on a regulated exchange. This allows the parties involved to specify the terms of the trade such as the quantity, quality, date, and location of the commodity delivery. This can be highly advantageous for both producer and consumer. Consumers have the ability to specify the exact amount of raw material that is required in the manufacturing process, which prevents waste or shortages. Producers also benefit because they may be able to sell a larger quantity than would be the case with standardized futures contracts.