Commodity Futures Traders

Hedgers and Speculators Buy and Sell Futures in Commodities

Nov 26, 2007

Commodity futures traders-the buyers and sellers who participate in futures markets-are either hedgers or speculators. This article explains the difference.

Futures hedgers and speculators have different motives and reasons for trading commodity futures. A hedger actually produces, needs, consumes or uses a commodity, while a speculator does not. The farmer who grows corn, and the distiller that buys it to produce bourbon whiskey, are hedgers. Ranchers that produce and sell cattle are hedgers, as are slaughterhouses that buy and process the animals.

Speculators participate in the futures market purely to make money. That’s why they’re called speculators. They have no interest in or intention of producing, consuming, using or taking delivery of any commodity. Speculators vastly outnumber hedgers. Although they are often maligned as greedy and parasitic, in truth it is speculators, not hedgers, who in risking their own money provide most of the stability and liquidity to the markets in which they participate (i.e., take positions).

Hedging is Like Price Insurance

Hedgers want price certainty (or at least less uncertainty), and the commodity futures markets provide it by transferring price risk, mostly to speculators. Indeed, that’s how and why such markets arose centuries ago. A wheat farmer planting in April wants assurance what price his crop will garner when he harvests in October. Rather than guess or hope what prices in the future will be, he sells his crop-to-be on a futures exchange in the spring, locks in a satisfactory price, delivers in the fall, and receives the agreed-upon amount. (Futures exchanges enable one to sell something one doesn’t actually own). Another hedger—perhaps a breakfast cereal manufacturer—buys wheat in April for October delivery, also at a known price. This enables the buyer-user to plan what it will pay for a critical raw material and enable the processor to intelligently set the selling price of its finished product without having to speculate about where raw material values are headed months or years in advance. Both parties thus avoid the consequences of adverse price fluctuations and volatility.

Hedging is like insurance. Hedgers transfer price uncertainty and risk to, and spread it among, the many indispensable speculators who inhabit the futures markets.

Hedgers don’t expect to substantially profit from their buying and selling activities (called positions) in the futures markets, but speculators most definitely do hope to reap considerable rewards. A speculator takes positions in the futures market expecting that his or her predictions of commodity price movements, up or down, are correct. If the prediction is right, the speculator makes money, often-spectacular amounts. A wrong prediction incurs losses, sometimes equally stellar.

What’s a Futures Position?

It’s a legal contract in which a competent buyer offers (bids) to purchase and accept delivery, and a competent seller accepts and agrees to sell and deliver (offers), at an agreed upon price and location, subject to the terms and conditions of the contract.

What Do Traders Buy and Sell?

Buyers and sellers purchase and sell (trade) contracts, each of which specify the what, where, when, who and how much of the commodity, and its price. For example, a crude oil contract stipulates:

Commodity contract specifications are clearly defined by the exchanges where futures are traded--the Chicago Mercantile Exchange (CME) for example.

The copyright of the article Commodity Futures Traders in Futures Investing is owned by George Daleiden. Permission to republish Commodity Futures Traders in print or online must be granted by the author in writing.