Commodity Futures

Commodity Futures

31-May-14 Financial Derivatives - Kevin
Commodity futures exchanges
 Three national multi-commodity futures
exchanges
 NMCE, Ahmedabad
 MCX, Mumbai
 NCDEX, Mumbai
 Single commodity futures exchanges
 International Pepper futures exchange, Kochi
 Coffee futures exchange of India, Bangalore
 The Forward Markets Commission (FMC) –
regulatory body for commodity futures trading
31-May-14 Financial Derivatives - Kevin
Gold futures specifications
 Exchange: NCDEX, Mumbai
 Product: Gold 100 grams
 Unit of trading: 100 grams
 Quotation: Rs. per 10 grams
 Tick size: Re.1
 Price limit: +/(-) 4 percent
31-May-14 Financial Derivatives - Kevin
Other details
 Three months contracts are available for
trading
 Expiry date: 20
th
day of delivery month or
the preceding working day, if 20
th
day is non
working day
 Trading hours:
 Mondays through Fridays: 10.00 AM to 11.30
PM
 Saturdays: 10.00 AM to 2.00 PM
31-May-14 Financial Derivatives - Kevin
Illustration – Commodity futures
for hedging
 A farmer has cultivated wheat and it is
growing
 Harvest is due in 2 months’ time
 Current price of wheat: Rs.10/ kg
 At harvest time, price may decline to Rs.8/ kg
 The farmer enters into a futures contract to
sell wheat after 2 months at Rs.9.50/ kg
 After 2 months, the farmer will be able to get
Rs.9.50/ kg for his wheat, whatever be the
price in the market at the time.
Commodity futures for
speculation
 Gold price is expected to rise in the short term
 You may buy gold coins to gain from the rise
in gold price
 Alternatively, you may buy gold futures (by
depositing only the margin)
 The futures transaction may be reversed when
the gold price rises
 Larger profit from smaller investment without
touching the underling commodity
31-May-14 Financial Derivatives - Kevin
Commodity prices: basics
 Spot price: price of a commodity for
immediate delivery
 Futures price: price agreed upon for delivery
in future at a particular location
 Spot price determined by demand and supply
 Two models try to explain the determination of
futures price
 Cost-of-carry model
 Expectations model
31-May-14
Financial Derivatives - Kevin
Cost-of-carry model
 Futures price must equal the spot price
plus the cost of carrying the commodity
forward to the delivery date
 Cost of carry includes cost of financing,
storage and insurance (expressed as a
fraction of the spot price)
 F = S (1 + C)
31-May-14 Financial Derivatives - Kevin
Expectations model
 Futures price equals the cash price that
traders expect to prevail on the delivery
date (i.e. the future spot price)
 F ~ E (S1)
31-May-14 Financial Derivatives - Kevin
Role of commodity futures
market
 Futures trading performs three important
economic functions
 Price discovery
 Transferring risk (through hedging)
 Providing liquidity to the market
(through speculation)
31-May-14 Financial Derivatives - Kevin
31-May-14 Financial Derivatives - Kevin
Website familiarisation
 Websites:
 www.ncdex.com
 www.mcxindia.com
 www.nmce.com
 Exercises
 List the commodities traded in each market
 Select any one commodity and write down
the spot price and the futures prices for two
contracts expiring in different months on any
working day from any one exchange