If your clients are looking for exposure to commodities in their portfolios, exchange traded funds (ETFs) are an easy way to get it without the hassle of buying and/or rolling futures contracts.

What Are Futures?

Futures, as they relate to commodities, are contracts between two parties.

Let’s use wheat as an example. Someone purchasing a December futures contract for wheat is locking in the current price of that contract, while the person selling such a contract is saying that they will deliver wheat at the price for which the futures contract was purchased.

As December approaches, one of three things usually happens:

  • Roll the contract and purchase another one for a later date
  • Take delivery of the wheat
  • Settle the contract for cash

A majority of the futures contracts traded on the exchange floor are settled or swapped for cash before the expiration date.

Speculators – those investing for profit – don’t usually want to take delivery; they’ll often own futures contracts in order to profit from rising commodity prices. For that reason, they want to sell before the contract expires to avoid the awkward situation of having a few tons of wheat show up on their doorstep.

Not everyone who owns futures has the same objective. For instance, a farmer would use futures to lock in a price for a commodity or livestock to reduce risk, or hedge. Airlines often hedge rising fuel prices by purchasing futures contracts.

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