InvestorQ : How can individual traders and businesses make the best use of commodity futures to reduce their risk?
sara Kunju made post

How can individual traders and businesses make the best use of commodity futures to reduce their risk?

Answer
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Rutuja Nigam answered.
1 year ago


For individual traders, commodity futures work exactly like equity futures and index futures. If you are expecting the price of crude oil to go up or if you are expecting the price of silver to go up, then you can buy crude oil or silver futures by paying the margin on the futures. Alternatively, if you are expecting the price to go down then you can also sell futures. These commodity futures allow individual traders to take a position based on their outlook of the commodity and make profits. Also, since the commodity prices are less volatile relatively, the margins chargeable are much lower. But how can businesses make the best of commodity futures?

Let us assume that you are the manager of a paint company. Obviously, the one thing you would be worried about is the price of crude oil because that is a critical input for paint manufacturing. Crude oil is your major input and you are expecting the price of crude oil to go up in the next 3 months due to OPEC supply shortfalls. You can hedge your risk by buying oil futures and lock in the current price. Similarly, if you are an oil refiner then you can protect your downside risk by selling oil futures well in advance. This will ensure that your price of sale is locked in. Like in case of any forward / future transaction, there is a trade-off that you have to be prepared for when you try to hedge your risk.