Business Finance

Agricultural Commodity Futures

Written by Bennet Grill for Gaebler Ventures

Small businesses that operate in the agricultural industry must understand how agricultural commodity futures work. In this business finance article, we offer a primer for understanding commodities futures.

Agricultural commodity futures have existed for hundreds of years.

From the rice crop in Japan to the Dutch tulip trade, there is a long history of commodity prices being negotiated for the delivery of agricultural products at a future date.

Unpredictable factors such as the weather and market demand often make it difficult for commodity producers to form a reasonable expectation on what price they will be able to charge for their product. Through the use of a futures contract, producers of commodities can guarantee a certain price at which they can sell their commodity at a future date. Similarly, buyers of large quantities of commodities use futures contracts to lock in a future purchase price today.

A future is a contract to purchase or sell a security at a specified price, the strike price, on a specified date in the future, the settlement date. Unlike an options contract, a future requires that the buyer of the contract engage in the transaction to purchase or sell the underlying security.

The United States Commodity Futures Trading Commission (CFTC) was established to regulate the commodity futures market-- the governing body has the authority to impose fines to participants and issues weekly publications called 'Commitments-Of-Traders-Reports' about the status of the commodities market.

The hedgers in the agricultural commodities market are most often farmers and store house owners. These participants' profit depends directly on the price of agricultural products. If the weather for a certain crop's season is unexpectedly favorable and the market is flooded with excess supply, farmers who were purchasers of futures contracts will not suffer from the resulting decrease in price. Conversely, commodity buyers who purchased a futures contract to purchase a specific crop will be forced to buy the crop at a premium to the market price. As in every derivative market, speculators such as hedge funds and investment banks also participate in the agricultural commodity futures market as investors looking for a profit but have no interesting actually purchasing or selling agricultural products.

Agricultural Commodity Future contracts are sold for the following crops:

• Coffee
• Orange juice
• Cotton
• Corn
• Sugar
• Wheat
• Soy bean
• Cocoa

To learn more about agricultural commodity futures, please visit http://www.cftc.gov/.

Bennet Grill is a writer who has a passion for business and finance. He is currently an Economics major at Duke University in North Carolina.

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