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CFA Level II Exam · Introduction to Commodities and Commodity Derivatives

Commodity Spot, Forward and Futures Markets Explained

Updated 7 October 2026 · Fact-checked

Commodities trade in the spot market for immediate delivery, and in forwards, futures and swaps for delivery or payment later. Forwards are private and customised. Futures are exchange-traded, standardised and margined daily. Swaps exchange cash flows. Hedgers reduce price risk and speculators take it. Match each contract to its features.

Understand Commodity Spot, Forward and Futures Markets

A commodity is a physical good such as crude oil, wheat, copper or gold. Its price depends on supply, demand, storage and transport. You can trade it in several markets, and the exam asks you to tell them apart.

In the spot market you buy or sell for immediate delivery at the current price. In the forward market two parties agree today on a price for delivery on a future date. A forward is an over-the-counter (OTC) contract. Terms such as quantity, quality, delivery place and date are customised. Each side bears the other's counterparty (credit) risk, and the contract usually has no daily cash flows.

A futures contract is similar in purpose but is traded on an exchange. Contract size, grade, delivery month and location are standardised. A clearinghouse stands between buyer and seller, which sharply reduces credit risk. Both sides post initial margin and are marked to market daily, with gains and losses settled through the margin account. Futures are also regulated and are very liquid, so you can close a position easily with an offsetting trade.

Futures settle in one of two ways. In physical settlement the seller delivers the actual commodity, to a specified location and grade. In cash settlement the parties pay the difference between the contract price and the final spot or reference price. Most participants close out before expiry, so few contracts end in delivery. Cash settlement is common where delivery is impractical.

A commodity swap is an OTC contract that exchanges cash flows over several periods. In a typical fixed-for-floating swap, one side pays a fixed price and receives a floating price tied to the spot or a benchmark, on a notional quantity. Swaps are usually cash settled. They let a producer or consumer lock in prices over many periods with one contract.

Hedgers hold or need the commodity and want to reduce price risk. A producer sells futures to lock in a selling price. A consumer such as an airline buys to lock in a cost. Speculators have no underlying exposure and take price risk seeking profit. They add liquidity. Arbitrageurs exploit mispricing between spot and futures. Others include index investors and financial institutions that act as dealers.

Key formulas to remember

Futures gain or loss (long)
Gain = (Settlement price − Previous settlement price) × Contract size × Number of contracts
A short position has the opposite sign. Used for daily marking to market.
Cash settlement amount
Payment = (Final reference price − Contract price) × Quantity
Positive means the long receives. Negative means the long pays.
Fixed-for-floating swap payment
Net payment to fixed payer = (Floating price − Fixed price) × Notional quantity
Positive means the fixed payer receives. Only the net amount is paid.
Margin rule
Margin call if account balance < maintenance margin; restore to initial margin
Check the vignette for whether the top-up is to initial or maintenance level.

How to solve Commodity Spot, Forward and Futures Markets questions

Use this method for any item-set question on commodity markets and contracts.

  1. 1Identify the contract: spot, forward, futures or swap. Look for words such as exchange, OTC, standardised or customised.
  2. 2Identify each party's position and exposure: producer, consumer, speculator or arbitrageur. Decide whether each is long or short the commodity.
  3. 3Find the numbers in the vignette: contract price, current price, quantity, contract size and number of contracts.
  4. 4Decide the settlement type: physical delivery or cash settlement, and whether cash flows occur daily or only at the end.
  5. 5Compute the gain, loss or net payment, keeping the sign correct for long versus short.
  6. 6Check risk features: credit risk, liquidity, margin and flexibility, and match them to the contract.
  7. 7Read all three options and choose the one that fits the vignette, not a general statement.

Quickest way: Contract feature checklist

When to use it: For conceptual questions comparing forwards, futures and swaps.

  1. If it says exchange, clearinghouse, margin or standardised, it is a futures contract.
  2. If it says OTC, customised or counterparty risk, it is a forward or swap.
  3. If cash flows repeat over several dates, think swap.
  4. For P&L, subtract in the right order: long gains when the price rises, short gains when it falls.
  5. Eliminate options that attribute speculator behaviour to hedgers or the reverse.

Common mistakes in Commodity Spot, Forward and Futures Markets

  • Saying futures have no credit risk at all.

    Students remember that the clearinghouse guarantees trades.

    Fix: Say credit risk is greatly reduced through margin and daily settlement, not eliminated.

  • Treating a forward as marked to market daily.

    Forwards and futures are confused because they serve the same purpose.

    Fix: Daily marking is a futures feature. A forward usually settles only at maturity.

  • Getting the sign wrong for the short position.

    Students compute the long result and forget to reverse it.

    Fix: Write long or short next to the answer. Short gain = contract price − final price.

  • Assuming all futures end in physical delivery.

    Delivery is the textbook definition.

    Fix: Most positions are closed before expiry, and some contracts are cash settled.

  • Calling every futures buyer a speculator.

    Students focus on the long position instead of the purpose.

    Fix: Classify by underlying exposure. A consumer buying futures to fix costs is a hedger.

Worked examples

Example 1

A gold producer sells 10 futures contracts at $2,000 per ounce. Each contract covers 100 ounces. At the next settlement the price is $1,985. (1) Is the producer a hedger or a speculator? (2) What is the day's margin account change? (3) What is the likely effect on credit risk?

Show the solution
  1. Part 1: The producer owns the underlying exposure and sells futures to lock in a price, so it is a hedger.
  2. Part 2: The producer is short. Price fell $15, so the short gains $15 per ounce.
  3. Total ounces = 10 × 100 = 1,000.
  4. Gain = $15 × 1,000 = $15,000 credited to the margin account.
  5. Part 3: Daily settlement through the clearinghouse limits accumulated losses, so credit risk is low.

Answer: Hedger; margin account increases by $15,000; credit risk is greatly reduced.

Example 2

A fixed-for-floating oil swap has a notional of 50,000 barrels per quarter. An airline pays a fixed price of $80 and receives the floating price. The floating price at the first settlement is $86. (1) Who pays whom? (2) What is the amount? (3) Is delivery of oil required?

Show the solution
  1. Part 1: The airline is the fixed payer. The floating price exceeds the fixed price, so the airline receives net.
  2. Part 2: Net = ($86 − $80) × 50,000 = $6 × 50,000 = $300,000.
  3. Part 3: Swaps are typically cash settled on a net basis, so no physical oil changes hands. The airline buys its fuel in the spot market.

Answer: The swap dealer pays the airline $300,000 net; no physical delivery is required.

Exam tips

  • Read who the party is and why it trades before choosing hedger or speculator.
  • Check the sign of every gain or loss, and whether the position is long or short.
  • Expect questions contrasting futures with forwards on credit risk, liquidity and customisation.
  • Watch for settlement wording: physical delivery versus cash settlement.
  • No wrong-answer penalty applies, so always answer after eliminating options.

Commodity Spot, Forward and Futures Markets in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Commodity Spot, Forward and Futures Markets: frequently asked questions

What is the difference between commodity futures and forwards?

Futures are standardised, exchange-traded and marked to market daily through a clearinghouse. Forwards are customised OTC contracts that usually settle at maturity and carry counterparty risk. Futures are generally more liquid.

What is the difference between physical and cash settlement?

With physical settlement the seller delivers the actual commodity. With cash settlement the parties pay the difference between the contract price and the final reference price. Cash settlement avoids storage and transport.

How does a commodity swap differ from a futures contract?

A swap is an OTC contract exchanging cash flows over several dates, often fixed for floating. A futures contract is exchange-traded, standardised and has a single delivery date. Swaps carry counterparty risk.

Who are the main commodity market participants?

Hedgers such as producers and consumers reduce price risk. Speculators take price risk for profit and add liquidity. Arbitrageurs exploit price gaps between related markets.