Commodities investing involves the purchase of investments that relate to food, energy or metals. Like stock trading, investing in commodities will typically require the use of a strategy or other plan for buying and selling these investments. Popular commodity investing plans include the use of futures contracts, hedges, speculation on future price movements and options, which are a derivative of an actual futures contract. Commodities investing can be more risky than investing in stocks, as large swings can occur in the commodities market that may be unforeseen by investors.
Futures contracts are the basic instrument in commodities investing. Individuals or businesses purchase contracts for the future delivery of a commodity, such as oranges, coffee beans, gold, currency or other items. This contract provides specific information on the commodity. The buyer and seller enter the agreement with a stated payment price for the commodity, amount of good purchased, delivery date and other factors that may affect the agreement. An essential piece of commodities investing is the future delivery date. Investors purchase the contract at a specific price, hoping the commodity’s price increases or decreases sharply, making the contract more valuable.
Hedging is the process where an investor will purchase offsetting contracts to ensure they offset any losses on their investments. For example, if an investor purchases a contract to buy 12 bushels of soybeans for $100 US Dollars (USD) per bushel, he may purchase an investment in a related security, such as coffee beans. If the soybean contract proves unprofitable, the coffee beans may result in a profit due to changes in the market, allowing the hedge to work in favor of the investor.
Speculators represent a group of investors who never expect to take delivery of the goods listed in the contract. In the commodities market, speculators purchase contracts that typically have a higher probability for future price changes, such as oil. These contracts are valuable because companies who desire to take delivery of the oil and refine it into gasoline or other petroleum products look for contracts at the lowest price. This falls into the theory of “buy low, sell high.”
In commodities investing, options represent the right to purchase a contract. Investors can assign the rights to other investors or companies that want to purchase the commodity. While options may not result in significantly large gains, they may have more mobility in the commodities market. Options typically have to be sold prior to the expiration date of the contract, or the option is worthless. Options can be for purchasing a futures contract and do not tend mirror the moves in price of the futures contract.