Understanding “Against Actual” Trading – A Distinctive Practice in the Commodity Market

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In this article, we delve into a prevalent trading practice in the commodity market.

What is “Against Actual” Trading?

The term “against actual” (abbreviated as AA) refers to a trading practice commonly executed in the futures commodity market. In this type of trading, parties holding opposing positions of the same commodity settle their contracts by exchanging them with each other based on a cash settlement determined by the price differential between the two contracts. This trading allows both parties to close their positions without the need to physically deliver/receive the actual commodities.

AA trades are highly significant for speculators or risk hedgers. Conversely, physical commodity buyers often request delivery of the actual goods specified in the contracts.

How Does “Against Actual” Trading Work?

The futures market has existed for centuries with a very practical purpose: allowing producers and buyers to establish reasonable prices for commodities before actual production. For example, a corn farmer may negotiate with a buyer to supply a certain amount of corn at a predetermined price on a specific date.

However, nowadays, a substantial portion of futures market participants do not actually intend to take delivery of the physical commodities in their contracts. Instead, they aim to speculate on the future prices of commodities. These speculative buyers support the commodity market by increasing liquidity, enabling other market participants to obtain efficient prices and execute large orders.

Since these buyers do not intend to take delivery of the commodities they purchase, they need a way to close their positions for cash. In an against actual trade, the holder of a futures contract nearing the delivery date will exchange that contract with another market participant who previously sold a futures contract for the same type of commodity. Subsequently, the two parties will exchange cash based on the price differential between the two futures contracts at the time of sale.

Example of an Against Actual Trade

Let’s consider two investors, A and B. Both participate in the futures commodity market with the intention of speculating on oil prices, but they hold opposite positions. Speculator A buys a futures contract for oil because she believes that the oil price will increase, while speculator B sells a futures contract for oil because he believes that the price will decrease.

Suppose the price of oil declines after both speculators execute their trades and is now approaching the delivery date. This means that Speculator A will soon have to take delivery of physical oil, while Speculator B will soon have to deliver physical oil. Neither party intends to take or deliver oil; they both only want to settle their contracts for cash.

The way both speculators can achieve their goal is by engaging in an against actual trade, exchanging their futures contracts with each other. Since the price of oil has decreased, Speculator A will pay an additional fee to Speculator B to reflect the fact that Speculator B’s futures contract is more valuable. This way, both speculators can realize their profits/losses without having to take or deliver physical commodities.