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among speculators. Commodities speculators are individuals or financial institutions who
buy and sell commodities solely for the purpose of making a profit from movements in
commodity prices. A sale of pork bellies^5 might represent a hog farmer selling his animals
to a meatpacker. But it also might represent one speculator selling to another, where both
are simply engaged in the business of buying things and hoping to make a profit by selling
them at a higher price. It may well be that neither speculator has the slightest interest in
either raising pigs or processing pork.
Commodities can be sold with the idea that the seller will provide the commodity in
question to the buyer right away. Such deals are often referred to as for immediate delivery
or spot (short for “on the spot”) transactions. Commodities also may be sold, however,
under an agreement where the seller agrees to provide the buyer with the specified com-
modity at some specified future date. Not at all surprisingly, this sort of arrangement is
called a futures transaction, and the agreement which the buyer and seller enter into
is called a futures contract. We call the date on which the commodity is to be provided
to the buyer by the seller the delivery date.
Prices for commodities can be extremely volatile, sometimes swinging wildly over
a short period of time. In part, this is due to the nature of the commodities themselves. If a
spell of weather starts to look like it is turning into a drought in a major coffee-producing
area, the price of coffee is likely to rise as both buyers and sellers begin to expect that a
poor crop will cause supply to fall short of demand. If rain then suddenly arrives and the
threat of drought subsides without major damage to the crop, the price may quickly drop
as the fear of a supply shortfall subsides. Weather forecasts change rapidly, and thus so
may the prices for agricultural commodities. Other commodities are not as subject to the
weather, but may be subject to other factors such as economic growth predictions, min-
ing accidents, labor strikes, and world politics. These moves are often exaggerated by
the actions of speculators. Buying and selling by speculators may affect the supply and
demand balance beyond actual physical supply and demand, exaggerating movements in
commodity prices.Hedging With Commodity Futures
Suppose that you are a soybean farmer looking ahead to harvesting your crop. Though the
harvest may be many months away, you are concerned about the price that you will be able
to get for your soybeans at harvest. If the price at harvest time is high, you may be able to
sell your crop for a large profit. On the other hand, though, if the price turns out to be low,
you may be faced with the prospect of selling at a loss, or putting your crop in storage in
hopes of higher prices later, assuming that you can do without the proceeds until that later
date and can absorb the cost of storage.
In order to limit the risk and uncertainty of what the market price for soybeans will be
down the road, you may choose to sell some of your expected crop on the futures market.
Suppose that, on the futures market today, soybeans for November delivery are selling for
$6.50 per bushel. You can then enter into a futures contract that will obligate you to sell
an agreed to number of bushels for that price in November. You will not be paid for those
future bushels of soybeans today. Instead, you have made a deal that obligates you to sell
the agreed number of bushels for this $6.50 price to whoever is on the other side of this
contract when November rolls around.
If the price of soybeans on the spot market is only $4.00 a bushel in November, the
owner of the contract will be nonetheless obligated to buy your soybeans for the agreed
$6.50. In that case you would be very happy to have made this deal. On the other hand,
if the spot market price is $10 a bushel in November, you are still obligated to sell them
for the agreed $6.50. In that case, you might not be so happy to have made this deal. The
chance that you might have to sell at a below-market price is the price you pay for the(^5) Pigs sold on the commodities market are traditionally referred to as “pork bellies.” Many commodities are referred
to professionally with names that seem comical at fi rst.
6.3 Commodities, Options, and Futures Contracts 275