Types of Transactions in Commodity Markets

1. Cash Contracts (Physical Market):

The cash contracts for the purchase or sale of commodities are those which call for payment of the full con­tract price in cash on delivery. Such contracts are made in the cash or physical market. In fact they are also referred to physical contracts in the sense that they deal in actual or physical products.

The cash or physical contracts may be subdivided into two subclasses:

(i) Spot Transactions:

Spot transactions are those cash contracts which involve the payment for the price by buyer and the delivery of the specified grade of goods by sellers immediately. These contracts relate to the purchase or sale of com­modities on spot. The essence of such contracts is the ready delivery and accep­tance of the delivery of the goods sold.

(ii) Forward Contracts:

Forward dealings are those cash contracts made in the cash or physical market which call for the delivery of goods and payment of the price after a specified period on a fixed date. The basic feature common to both the spot contracts and the forward con­tracts is that they are made and settled not necessarily in the premises of the commodity exchange. That is to say, the cash contracts are generally made out­side the exchange.

2. Futures Contracts:

A futures contract is a special type of agreement made strictly under the rules of a commodity which may or may not call for the actual delivery of goods and payment of price in cash on a future date.

A futures contract has been defined “as a contract for the future deliv­ery of some commodity without reference to spe­cific lots, made under the rules of some commer­cial body, in a set form, by which the conditions as to units of amount, the quality and time of deliv­ery are stereotyped, and only the determination of the total amounts and the price is left open to the contracting parties”. 

This definition brings out the following fea­tures of a futures contract:

(i) Such contracts are meant exclusively for future settlement through the exact data of settlement is decided by reference to the wishes of the seller and the estab­lished rules of the commodity exchange.

 (ii) Such contracts do not specify the par­ticular grade of a commodity but impliedly refer to a basic grade called the contract grade accepted as the com­mon grade for all futures dealings.

(iii) The details in respect of the unit of amount, the time of settlement, the qual­ity etc. are mentioned in the rules and regulations and are common to all such contracts. The contracting parties have to decide upon the price at which the contract is to be settled sometime in one of the trading months specified by the exchange.

The meaning of futures will be clear if the fol­lowing basic features of such contracts are referred to:

1. Futures contracts are made only in the ring of the commodity exchanges and not outside the exchanges.
2. Only members of commodity exchange can enter into such a deal. No outsider can become a party to a futures agreement.
3. Such contracts can be made only in multi­ples of a fixed unit of trading specified in the rules of the exchange. No such contracts can be made in fractions of these units.
4. The futures contracts are settled only in the trading months adopted by exchange. Every ex­change specifies 3 to 4 months in a year for settle­ment of such contracts.
5. The time of delivery is not specified in these contracts. It is left to the choice of the seller. The seller may settle the contract on any day of the trad­ing month for which the delivery was fixed.
6. As per rules of the exchange the contract­ing parties have to deposit a certain percentage of the contract price with the exchange as “margin money’ whenever they make a futures contract.
7. Since futures contracts are entered into only under the rules of the commodity exchange con­cerned, all disputes between contracting parties are required to be settled through arbitration by the machinery provided for the purpose.

The futures contracts differ from cash contracts not only in respect of the above features but also in regard to the basic purposes for which they are made. All futures contracts are generally made for the purpose of speculation or hedging. The gen­eral procedure for settlement is the neutralisation of the original contract by an opposite contract on settlement so that only difference between the cur­rent and the contract price is paid.

It is rarely that actual delivery of goods is taken and price paid in settlement of futures contracts. Cash contracts are made for actual purchase and sale of the commodi­ties. Under these contracts the commodity is deliv­ered and the price paid in full, though in some cases price differences may be paid. The futures market is also called the exchange market as against physi­cal market which is another name for cash market.

The futures trading are the most important fea­ture of business activity on the commodity ex­change. In fact, the commodity exchanges are or­ganised mainly for futures contracts. The futures contracts are made for speculative and hedging purposes.