How Does a Futures Contract Work in Hedging a Commodity Price?

A futures contract is an agreement to buy or sell a specific quantity of a commodity at a predetermined price on a future date. A producer of a commodity can hedge against falling prices by selling a futures contract.

This locks in a selling price for their future production. Conversely, a consumer of that commodity can hedge against rising prices by buying a futures contract, which locks in a purchase price.

This strategy helps both parties mitigate the risk of price volatility.