Trading in Futures has been realized as an important strategy for price risk aversion in commodities. The commodity futures markets provide a means to transfer risk between persons holding the physical commodity and other hedgers or persons speculating in the market. Futures exchanges exist and are successful based on the principle that hedgers may forgo some profit potential in exchange for less risk and speculators will have access to increased profit potential from assuming this risk.

Mechanics of futures trading

 Forward contract is an agreement between two parties in which the seller agrees to deliver to the buyer a specified quantity and quality of an asset or commodity at a specified future date at an agreed upon price. A forward contract is a privately negotiated bilateral contract that is not conducted on an organized marketplace or exchange. The contract terms are not standardized but are determined by what the parties agree on. The price generally is determined when the contract is entered into, although there are some forward contracts where the parties may agree to transact at a price to be determined later in a manner that is specified on the day the contract is entered into.

Forward contracts are primarily merchandising vehicles, whereby both parties expect to make or take delivery of the commodity on the agreed upon date. It is difficult to get out of a forward contract unless both the parties/persons agree to extinguish the contract. To enter into a forward contract, it is also necessary to find someone who wants to buy exactly what you want to sell when and where you want to sell it. As such, forward contracts are commonly used as merchandising vehicles in a variety of commodity and currency markets; however, forward contracts lack certain features that make futures contracts especially useful for hedging.

Clearinghouses Futures trades that are made on an exchange are cleared through clearinghouses that act as the buyers to all sellers and the sellers to all buyers. When a trader/participant enters into a futures contract, he is technically buying from or selling to, the clearinghouse rather than the party with whom he executed the transaction on the trading floor or through an electronic trading platform. Thus, since he ultimately buys and sells from the same party, if he buys a futures contract and subsequently sells it, he has offset his position and the contract is extinguished. On the other hand, if he buys a forward contract and then sells an identical forward contract to a different person, he has obligations under two contracts (one long and one short).