Differentiate between Commodity Futures Contracts and Commodity Option Contracts.

Commodity futures contracts A futures contract is an agreement for buying or selling a commodity at a predetermined delivery price at a specific future time. Futures are standardized contracts that are traded on organized future exchanges that ensure performance of the contracts and thus remove the default risk. The major function of futures markets is to transfer price risk from hedgers to speculators. For example, if a farmer is expecting his crop of wheat to be ready in two months time, but is worried that the price of wheat may decline in this period. In order to minimize the risk, he can enter into a futures contract to sell his crops in two months' time at a price determined now. In this way he is able to hedge his risk arising from a possible adverse change in the price of his commodity. Commodity option contracts Options are used for hedging and speculation. The commodity option holder has the right, but not the obligation, to buy (or sell) a specific quantity of a commodity at a specified price on or before a specified date. Option contracts involve two parties- the seller of the option writes the option in favour of the buyer who pays a certain premium to the seller as a price for the option. There are two types of commodity options: a call option gives the holder a right to buy a commodity at an agreed price (called exercise price), while a put option gives the holder a right to sell a commodity at an agreed price, on or before a specified date (called exercise date).