What are commodity futures?
Commodity futures are contracts that enable you to buy or sell a set amount of a commodity for a set price on a set day.
At the point of expiry, futures contracts have to be settled in some form – unlike options contracts which can be left unexecuted at expiry. While futures contracts can result in the physical delivery of the asset, most traders choose to settle their position in cash or roll over the trade to the following expiry date.
Futures were originally created to give companies a way of safeguarding their revenue streams against dramatic price fluctuations in materials, but now most futures trading volume comes from hedgers and speculators.
Futures are the most common means of speculating on commodities, as their prices move up or down in line with the underlying asset.
What are commodity spot prices?
A commodity spot price represents the cost of exchanging an asset immediately – or ‘on the spot’. Traditionally when using the spot market, you’d physically take ownership of the commodity you’ve exchanged, but it has become used for speculation and hedging – just like futures.
It’s important to note that since delivery ‘on the spot’ is not possible practically, the seller is given 5-7 days to honour the contract.
It’s also likely that if you want to physically buy a commodity on the spot, there will be additional costs that come with the process of turning the raw material into a useable good. For example, if you wanted to buy spot gold, the price listed is for one ounce of gold, but you’d typically buy gold in bars or coins.
Differences between commodity futures and spot prices
While futures and spot prices are types of purchasing agreements for commodities, they differ in the time and date of execution. A futures contract refers to a deal that’s going to happen at a later expiry date, while spot commodity deals are executed immediately.
For example, you can either buy gold in the spot market and take delivery straight away, or you can buy gold in the futures market and decide before the settlement date whether to take delivery or not.
Here’s a more detailed breakdown of the differences between the two:
|When is the contract settled?||On a specified expiry date||Immediately|
|What strategy is the agreement used for?||Longer-term positions||Short-term trading|
|How is the deal settled?||Physically, in cash or rolled over||Physically or in cash|
|Is there a fixed expiry?||Yes||No|
|Are there overnight funding costs?||No||Yes|
|Are there rollover charges?||Yes||No|
|What is the technical analysis timeframe?||Charts are only available within the expiry period||Continuous charting is available|
The relationship between the spot price and futures price is described by the terms contango and backwardation. Contango occurs when the futures price is higher than the spot price of the underlying, while backwardation occurs when the futures price is lower than the spot price of the underlying.
Futures prices do tend to trade at a premium to spot prices, due to the cost of carry – the costs a seller has to incur to maintain their holding over the time period. This could include insurance, storage costs and so on.
Example of a commodity trade
Let’s take a look at each type of contract in an example, in which you believe the price of WTI oil is going to rise from the current market price of $65 per barrel.
Scenario one: buying a futures contract
You buy a futures contract for 100 barrels of oil at $70 each, with an expiry for one month.
As the end of the month approaches, the price of WTI has risen to $75 a barrel, and you close your position. Your contract means you can buy 100 barrels of oil at $70 each, rather than the current market price. This means you’ve saved $500 ($5 x 100). If you didn’t want to take ownership of the oil, you’d just settle the position in cash, or sell the contract on to someone else.
However, if the price of WTI had remained the same or fallen, you’d have to close your contract at your chosen price of $70, which could be much higher than the new going rate – meaning you’d make a loss on the position.
Scenario two: buying at the spot price
As you believe the price of WTI is going to rise from its current price of $65, you decide to buy 100 barrels of oil in the spot market. Your trade would be executed immediately, and you’d pay $65,000 to the seller. The vast majority of spot contracts involve the physical delivery of the asset, some brokers will allow you to settle in cash.
At a later date, if the price had risen, you could sell your holding on at the new market price, earning a potential profit.
How to buy commodity futures
Buying commodity futures involves entering a commodity market via a broker, as exchanges can only be accessed by clearing members – these are usually institutions rather than individual traders. Once you’ve entered the futures contract, you’d be obliged to uphold your end of the deal regardless of whether the market price increases or decreases.
Alternatively, you can trade on the price of commodity futures via derivatives such as CFDs. You wouldn’t be entering the futures agreement, but rather speculating on whether the price of commodity futures will rise or fall before the date of expiry. Your profit or loss would be determined by the extent to you which you’re correct.
CFDs are leveraged products, so you’ll still only need to put down a fraction of the value of your trade to open a full position. As with standard futures, leverage can magnify your potential profits but does also come with increased risk. However, when you trade via CFDs, you can manage your risk via stops and limits, which enable you to set entry and exit points for your trades based on your risk appetite.
Find out more about CFD trading.
How to buy spot commodities
Buying commodity spot is usually also done directly on a commodity exchange, so retail traders and investors will need to execute their transactions via a broker. However, you can also speculate on the price of spot commodities with CFDs.
We price our non-expiring commodity markets (spot prices) using two sufficiently liquid futures contracts on the underlying commodity. This is usually the two with the nearest expiry date.
Learn more about our pricing
Our spot markets have continuous charting, which also means you can also perform technical analysis over much longer timeframes.
How to trade commodity futures and spot prices
You can trade commodities via futures or spot prices in just a few quick steps:
- Learn how to trade CFDs
Find out how CFDs work and the benefits of trading derivatives
- Create an account with City Index
Get started trading on live markets, or practise trading first in a risk-free demo account
- Search for the commodity you want to trade
Find your futures or spot market in our award-winning platform
- Decide whether you want to go long or short
Click ‘buy’ if you think the market will rise in price, and ‘sell’ if you think it will fall
- Open your position
Enter the market by clicking ‘place a trade’, you may want to consider adding a stop loss to your trade to manage your risk
- Monitor and close your trade
Use analysis to stay up to date with any price movements and identify an exit point for your position
How do you hedge commodities with futures?
You can hedge changes in commodity prices with futures by locking in a more favourable price in advance. You’d do this by taking a long position in a futures contract, buying the commodity in the expectation it will rise in price, and you can then buy it at your predetermined (hopefully lower) price.
However, if the commodity has fallen in price at the date of expiry, you’d have to buy at the agreed higher price.
You can also hedge against an existing long position by ‘selling’ your assets via a futures contract. At the date of expiry, you’d be hoping to sell your commodity for the predetermined higher price and rebuy the asset at a lower price.
To make things easier, you can speculate on the changing market prices with CFDs. You’d never need to take ownership of the underlying commodity, but rather just place a bet on whether the market price will rise or fall.
Learn about hedging strategies
How do you trade crude oil futures?
You can trade crude oil futures by opening an account with a broker, and either entering into a futures contract or speculating on the market price via derivatives.
Crude oil futures contracts are standardised agreements to exchange oil for a set price on an agreed date. Usually a crude oil future will be worth 100 barrels. At the point of expiry, the contract is either settled – physically or in cash – or is rolled over to the next expiry date.
Learn more about how to trade oil
Can you buy gold at the spot price?
Typically, no, you can’t buy physical gold at the spot price as there are a lot of other costs that go on top of the precious metal. For example, gold comes in the form of gold bars and coins – known as bullion – which costs more because it needs to be refined.
If you buy spot gold, you’ll also need to consider how you’ll store the precious metal and insure it. But if you just speculate on the price of spot gold – via CFDs – you won’t have to worry about this as you’ll never take ownership of the underlying gold.
How do you buy silver at the spot price?
Buying silver at the spot price is somewhat complex, as there’s a lot more that goes into the physical transaction than just the metal alone. You’d need to think about insurance and storage costs too. However, you can buy silver bullion with the appropriate broker.
Alternatively, you can speculate on silver spot prices with CFDs. You won’t have to worry about the cost of insurance or storage, as you’ll never take ownership of the physical metal.
What is the spot price of oil?
The spot price of oil is the price it would cost for a one-off transaction of oil in the near-term. It reflects the current market price for oil, rather than the future price that buyers and sellers are willing to deal at.
The spot oil market is comparatively small, as most transactions take place in the futures market. Spot oil traders tend to be producers, refiners and professional trading firms, rather than retail traders. This is because a lot of spot oil transactions are for the physical commodity.