What Is a Cash Commodity?
A cash commodity is a tangible product to be delivered in exchange for payment and is seen most frequently with futures options. A contract for a cash commodity will specify the exact amount of the commodity which is expected to be delivered, along with the delivery date, and the price. Cash commodities can include agricultural products, minerals, oil, and gold. Are treasury bond commodities? Yes, they are.
Cash commodities are also sometimes referred to as actuals.
- A cash commodity is a tangible product given as payment for a good.
- Companies enter into contracts for cash commodities because they are betting on a specific price for a commodity they plan to use.
- Speculators are often interested in capitalizing on the change of the commodity’s price rather than the commodity itself.
Understanding Cash Commodity
A cash commodity is a tangible commodity for which a person or company has a use. Companies enter into contracts for cash commodities because they are betting on, or hedging, the price for a commodity that they need.
For example, a prominent sausage manufacturer may anticipate the price of pigs going up over the next six months. To lock in a reasonable price on the meat they need for production, they may execute a futures contract.
With the futures contract, the sausage company agrees to buy a certain number of pigs for a set price at a predetermined date. This date may be, for example, three months in the future. At that date, the company will receive a delivery of pigs in exchange for their payment commodities. The company was not speculating, because they were counting on the physical delivery of pigs, which they use in the production of their product.
It is vital that contracts clearly state whether an actual cash commodity is expected for delivery at the contract's end or earlier. This requirement is because some commodities and futures contracts are cash-settled, which means that no physical goods change hands through the contract.
Speculating and Hedging Cash Commodities
In cash-settled contracts, only money changes hands, rather than the actual physical commodities. A contract would be cash-settled if the purchaser of the commodities was a speculator who was not actually interested in having the physical commodity but has an interest in the price fluctuations.
Speculators may only be interested in capitalizing on the change of the commodity’s price. A speculator may buy a shipment of corn at a low price, for example, and then sell it at a profit when the price of corn goes up. Through the use of a broker, it is possible for this investor never actually to have physical possession of this shipment of corn.
In actuality, our sausage company example and a speculator may purchase that same lot of pigs for the same price at the same time through a futures contract. But in the case of the speculator, that person does not actually want 10 truckloads of pigs delivered to their door.
They are only trying to profit off of the change in prices that they anticipate in the price of pigs. Thus, this futures contract would be cash-settled, as opposed to settled through the cash commodity.