Agricultural Futures Contracts

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Contributor, Benzinga
January 13, 2023

Agricultural futures contracts are standardized agreements to buy or sell a particular quantity of a commodity at a predetermined price at a particular date in the future. Contracts are traded on futures exchanges like the Chicago Mercantile Exchange or the Minneapolis Grain Exchange.

Market participants use agricultural futures contracts to hedge against price fluctuations in crops, livestock and other agricultural products. For example, a farmer concerned that corn's price may fall before his crops are ready for the market may sell corn futures contracts to lock in a specific price for his crop. A strategy that aims to hedge against unfavorable price changes in corn. Similarly, a grain elevator operator may buy corn futures contracts to lock in a price for the corn they will purchase from farmers.

Traders, speculators and other market participants also use agricultural futures contracts to bet on the direction of prices. They may buy futures contracts if they believe that prices will rise in the future or sell futures contracts if they think that prices will fall.

Agricultural futures contracts have expiration dates, meaning they must be settled or closed out before they expire, typically by making an offsetting trade in the futures market or by taking delivery of the underlying commodity.

Types of Agricultural Commodities Traded via Futures Contracts

Agricultural commodities are goods produced through farming and agricultural practices. Grains, livestock and soft commodities are some of the more common types of agricultural commodities traded via futures contracts.

Grains: Grains are one of the most commonly traded agricultural commodities. Examples of grain futures contracts include corn, wheat, oats and rice. Grains are used as a source of food, animal feed and industrial products.

Livestock: Livestock futures contracts include cattle, hogs and sheep. These contracts hedge against price fluctuations in the prices of live animals or the products derived from them, such as meat or milk.

Soft commodities: Soft commodities, also known as "softs," are agricultural products such as cocoa, coffee, cotton, orange juice and sugar, typically grown in tropical regions. Soft commodities are a key component of the agricultural futures market.

Each agricultural commodity has unique characteristics that can affect its price and market dynamics. For example, grains are subject to weather conditions, such as drought or excessive rainfall, which can impact their supply and demand. Livestock prices can be affected by meat demand and feed costs. Soft commodities are subject to political instability in the countries where they are produced or changes in consumer demand.

How to Invest in Agricultural Futures Contracts

Investing in agricultural futures contracts can be complex and risky, but it can also offer the potential for significant returns. Here are some steps to consider when investing in agricultural futures contracts:

Choose a futures broker: You will need to open an account with a futures broker. Research available brokers and select one that meets your needs. Consider factors such as the broker's reputation, fees and the types of agricultural futures contracts it offers.

Research and analyze contracts: Thoroughly research and analyze the contracts you are interested in. Weigh factors such as the commodity's supply and demand, weather conditions and global economic trends that could affect its price. You should also consider the expiration date of the contract and the margin requirements.

Place orders: Once you have chosen a broker and selected the contracts you want to trade, you can place orders through your broker's trading platform. You can use different orders, such as market orders, limit orders and stop-loss orders. 

Manage your portfolio: Regularly review and manage your portfolio by adjusting your positions, setting stop-loss orders and diversifying across different agricultural commodities.

Tips for successful investing in agricultural futures contracts:

Diversify your portfolio: One way to manage risk is to diversify your portfolio by investing in various agricultural futures contracts rather than putting all of your money into one commodity.

Use risk management techniques: Consider using risk management techniques, such as setting stop-loss orders, to protect against potential losses.

Stay informed: Keep up to date with the latest market news and trends that could affect the price of agricultural futures contracts.

Where to Invest in Futures

Benefits and Risks of Investing in Agricultural Futures Contracts 

Investing in agricultural futures contracts can be complex and risky, but it also has unique benefits. Some of the benefits include:

Speculation: Agricultural futures contracts allow investors to speculate on the direction of prices for various agricultural commodities. If you believe prices will rise, you can buy futures contracts; if you think that prices will fall, you can sell futures contracts.

Potential for high returns: Agricultural futures contracts can offer the potential for high returns, especially if prices move significantly in the direction you anticipate.

Hedge against price fluctuations: Agricultural futures contracts are primarily used as a hedge against price fluctuations for farmers, grain elevators and other market participants exposed to price risk for agricultural commodities.

However, there are also potential risks to consider when investing in agricultural futures contracts:

Possibility of large losses: Agricultural futures contracts carry significant risks, and it is possible to incur large losses if prices move against your position.

Impact of external factors: Agricultural commodity prices can be affected by several external factors, including weather conditions, political instability and changes in global economic conditions. These factors can create significant price fluctuations and increase the risk of investing in agricultural futures contracts.

Complexity: Agricultural futures contracts can be complex and may require a high level of expertise to trade successfully. 

Examples of Agricultural Futures Contracts

Here are some examples of agricultural futures contracts available for trade:

  1. Corn futures: These futures contracts are based on the price of corn, and the contract size is 5,000 bushels. The tick size (minimum price movement) is $0.0025 per bushel, and the contracts typically expire in March, May, July, September and December. To trade corn futures, you must open a futures account with a broker and deposit a margin (collateral) to cover potential losses. You could buy or sell corn futures contracts through the broker's trading platform.
  2. Live cattle futures: The specifications for live cattle futures contracts are as follows: contract size of 40,000 pounds with a minimum tick size of $0.025 per pound, and the contracts typically expire in February, April, June, August, October, and December. 
  3. Lean hog futures: Based on the price of lean hogs, the specification for these futures are a contract size of 40,000 pounds and a minimum tick size of $0.025 per pound, and the contracts typically expire in February, April, May, June, July, August, October and December. 

Hedge Farm Products with Futures

Agricultural futures contracts are financial instruments that allow investors to speculate on or hedge against the price movements of farm commodities. These contracts are standardized agreements traded on futures exchanges and can include a variety of commodities such as grains, livestock and soft commodities. Adding them to a portfolio can provide diversification, which can potentially improve risk-adjusted returns.