COMMODITY FUTURES IN INDIA

ASHISH KRISHNAN

DRASHTI BHAYANI

PROF. PINAKIN JAISWAL

PREPARED BY: GUIDED BY:

WHAT IS COMMODITY FUTURES

Commodities futures are an agreement to buy or sell a commodity at a specific date in the future at a specific price. Just like the price of bananas at the grocery store, the prices of commodities change on a weekly or even daily basis.

If the price goes up, the buyer of the futures contract makes money, because he gets the product at the lower, agreed-upon price and can now sell it at the today's higher market price. If the price goes down, the futures seller makes money, because he can buy the commodity at the today's' lower market price, and sell it to the futures buyer at the higher, agreed-upon price.

COMMODITY FUTURES IN INDIA

Commodity futures trading in India was in a state of hibernation for four decades, which was marked by suspicion on the benefits of futures trading. This is replaced by policy, institutional and market activism in the last few years. This is partly a response to the predominant role being assigned to the market forces in price determination and the consequent need for providing market-based de-risking tools.

It is also the result of a growing awareness that derivatives trading do perform substantial risk mitigating functions to the stakeholders.

This resurgence of interest in commodity derivatives is timely since global commodity cycle is on the upswing, and experts have predicted that we are in the decade of the commodities.

COMMODITY FUTURES IN INDIA

The most important changes that have taken place in the commodity futures space were the removal of prohibition on futures trading in a large number of commodities and the facilitation of setting up modern, demutualised exchanges by the Government of India.

These two initiatives together are becoming instrumental in changing the contours of the commodity futures markets in India in terms of both participation and practices.

There are, however, still a number of obstacles in fully exploiting the opportunities available to the commodity eco-system.

LIST OF TRADED COMMODITIES

Agricultural product:- Corn, Oats, Rough Rice, Soya beans, Rapeseed, Soya bean Meal, Soybean Oil, Wheat, Cocoa, Coffee, Cotton No.2, Sugar No.11,Sugar No.14.

Livestock and Meat:- Lean Hogs, Frozen Pork Bellies, Live Cattle, Feeder Cattle.

Energy:- WTI Crude Oil, Brent Crude, Ethanol, Natural Gas, Heating Oil, Gulf Coast Gasoline, RBOB Gasoline, Propane, Uranium.

Precious Metal:- Gold, Platinum, Palladium, Silver. Industrial Metals:- Copper, Lead, Zinc, Tin, Aluminum,

Aluminum alloy, Nickel, Aluminum alloy, Recycled steel

EXCHANGES WHERE COMMODITIES FUTURES ARE TRADED IN INDIA

The National Commodity and Derivative Exchange, the Multi Commodity Exchange of India Ltd and the National Multi Commodity Exchange of India Ltd.

All three have electronic trading and settlement systems and a national presence.

Apart from that there is Ace Derivatives & Commodity Exchange Ltd., Bhatinda Om and Oil Exchange Ltd and Universal Commodity Exchange

HOW TO CHOOSE A BROKER

Several already-established equity brokers have sought membership with NCDEX and MCX.

The likes of Refco Sify Securities, SSKI (Sharekhan) and ICICIcommtrade (ICICIdirect), ISJ Comdesk (ISJ Securities) and Sunidhi Consultancy are already offering commodity futures services.

WHAT IS THE MINIMUM INVESTMENT NEEDED

One can have an amount as low as Rs 5,000. All one needs is money for margins payable upfront to exchanges through brokers. The margins range from 5-10 % of the value of the commodity contract.

For trading in bullion, that is, gold and silver, the minimum amount required is Rs 650 and Rs 950 for on the current price of approximately Rs 65,00 for gold for one trading unit (10 gm) and about Rs 9,500 for silver (one kg).

The prices and trading lots in agricultural commodities vary from exchange to exchange (in kg, quintals or tonnes), but again the minimum funds required to begin will be approximately Rs 5,000.

DELIVERY/SETTLEMENT IN CASH

One can do both. All the exchanges have both systems - cash and delivery mechanisms. The choice is up to the individual. If one wants his/her contract to be cash settled, one has to indicate at the time of placing the order that he/she does not intend to deliver the item.

If one plans to take or make delivery, one needs to have the required warehouse receipts. The option to settle in cash or through delivery can be changed as many times as one wants till the last day of the expiry of the contract.

HOW TO START TRADING IN COMMODITY FUTURES

As of now one will need only one bank account.

One will need a separate commodity demat account from the National Securities Depository Ltd to trade on the NCDEX just like in stocks.

WHAT ARE THE BROKERAGE OR TRANSACTION CHARGES

The brokerage charges range from 0.10-0.25 per cent of the contract value. Transaction charges range between Rs 6 and Rs 10 per lakh/per contract.

The brokerage will be different for different commodities. It will also differ based on trading transactions and delivery transactions. In case of a contract resulting in delivery, the brokerage can be 0.25 - 1 per cent of the contract value. The brokerage cannot exceed the maximum limit specified by the exchanges.

WHO IS THE REGULATOR

The exchanges are regulated by the Forward Markets Commission. Unlike the equity markets, brokers don't need to register themselves with the regulator.

The FMC deals with exchange administration and will seek to inspect the books of brokers only if foul practices are suspected or if the exchanges themselves fail to take action. In a sense, therefore, the commodity exchanges are more self-regulating than stock exchanges. But this could change if retail participation in commodities grows substantially.

PLAYERS IN COMMODITY FUTURES

The commodities market will have three broad categories of market participants apart from brokers and the exchange administration - hedgers, speculators and arbitrageurs. Brokers will intermediate, facilitating hedgers and speculators.

Hedgers are essentially players with an underlying risk in a commodity - they may be either producers or consumers who want to transfer the price-risk onto the market.

Producer-hedgers are those who want to mitigate the risk of prices declining by the time they actually produce their commodity for sale in the market; consumer hedgers would want to do the opposite.

IN CASE OF DEFAULT

Both the exchanges, NCDEX and MCX, maintain settlement guarantee funds.

The exchanges have a penalty clause in case of any default by any member. There is also a separate arbitration panel of exchanges.

MARGIN APPLICABLE IN THE COMMODITIES MARKET

As in stocks, in commodities also the margin is calculated by (value at risk) VaR system. Normally it is between 5 per cent and 10 per cent of the contract value.

The margin is different for each commodity. Just like in equities, in commodities also there is a system of initial margin and mark-to-market margin. The margin keeps changing depending on the change in price and volatility.

CIRCUIT FILTERS

Yes the exchanges have circuit filters in place. The filters vary from commodity to commodity but the maximum individual commodity circuit filter is 6 per cent.

The price of any commodity that fluctuates either way beyond its limit will immediately call for circuit breaker.