1. 25 Investments: Introduction
  2. 25 Investments: American Depository Receipt (ADR)
  3. 25 Investments: Annuity
  4. 25 Investments: Art and Collectibles
  5. 25 Investments: Bonds
  6. 25 Investments: Cash
  7. 25 Investments: Closed-End Investment Fund
  8. 25 Investments: Common Stock
  9. 25 Investments: Convertible Bonds
  10. 25 Investments: Corporate Bond
  11. 25 Investments: Futures Contract
  12. 25 Investments: Life Insurance
  13. 25 Investments: The Money Market
  14. 25 Investments: Mortgage-Backed Securities
  15. 25 Investments: Municipal Bonds
  16. 25 Investments: Mutual Funds
  17. 25 Investments: Options (Stocks)
  18. 25 Investments: Exchange-Traded Funds
  19. 25 Investments: Preferred Stock
  20. 25 Investments: Private Equity
  21. 25 Investments: Real Estate & Property
  22. 25 Investments: Real Estate Investment Trusts (REITs)
  23. 25 Investments: U.S. Treasury Securities
  24. 25 Investments: Unit Investment Trusts (UITs)
  25. 25 Investments: Venture Capital
  26. 25 Investments: Zero-Coupon Securities
  27. 25 Investments: Conclusion

A futures contract is a specific form of forward contract where a buyer and seller agree to buy/sell a commodity at a set price in the future.  A future simply takes care of this transaction on a formal futures exchange, such as the Chicago Board of Trade or Mercantile Exchange. 

 

A commodity is a basic raw material.  It can include corn, wheat, livestock such as cattle, metals such as copper, coffee, and steel.  Essentially, anything produced from agriculture or a result of mining is likely a commodity that can trade on a futures exchange. 

 

Specifically, someone buying an April Canola contract at $5 a pound is obligated to accept delivery of 100 pounds of canola during the month of April at $5 per pound. Selling a futures contract means you are obligated to deliver these goods. The same concept applies to buying a futures contract on any other asset. It is important to know that a very high portion of futures contracts trades never lead to delivery of the underlying asset; most contracts are "closed out" before the delivery date. (For an in-depth look at the futures market, read our Futures Fundamentals tutorial.)

 

Objectives and Risks

 

Investors in futures contracts can either look to hedge or speculate in the market.  The best example of an investor looking to hedge is a farmer who might want to protect against a potential drop in the price of his or her corn following an abundant harvest and fall in prices due to high supply.  S/he could lock in current prices to offset the risk of them falling by the end of the season.

 

Speculators may not hold or have underlying exposure to a commodity but instead are interested in speculating on either a price rise or fall.  Both hedgers and speculators are needed to make a market, and liquidity is enhanced by both parties existing in the market.

 

Commodities do offer some level of general inflation protection.  Of course when prices rise, it represents inflation and the buyer of a futures contract will benefit.  They also offer diversification from stocks and bonds in that prices move based off underlying supply and demand dynamics of the underlying commodity and not more general financial market conditions.

 

How To Buy or Sell It

 

It is more difficult for individual investors to trade on organized futures exchanges.  However, many mutual funds and exchange traded funds offer liquid access to commodities and futures-based approaches to trade in the market.

 

Strengths

 

Great for hedging risk

Creates a marketplace for commodities

Individual investors can use funds or ETFs for exposure

 

Weaknesses

 

Relatively illiquid

Much more complicated than stocks or bonds

Price volatility

 

Key Considerations

 

Liquidity:  Low

Historical Returns:  Medium

Inflation Protection:  Medium


25 Investments: Life Insurance
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