“STUDY PROJECT ON THE GROWTH OF COMMODITY TRADING IN INDIA A CRITICAL ANALYSIS ON COMMODITY TRADING AT COMMODITY MARKETS A Project report submitted in partial fulfillment of the requirements for the award of the Degree in Master of Business Administration in"Christ University" Submitted By MOSES.D. Register Number - 1122009
DEPARTMENT OF MANAGMENT STUDIES, CHRIST UNIVERSITY HOSUR ROAD BANGLAORE – (2012-13)
Introduction to Commodity Trading What is “Commodity”? Any product that can be used for commerce or an article of commerce which is traded on an authorized commodity exchange is known as commodity. The article should be movable of value, something which is bought or sold and which is produced or used as the subject or barter or sale. In short commodity includes all kinds of goods. Indian Forward Contracts (Regulation) Act (FCRA), 1952 defines “goods” as “every kind of movable property other than actionable claims, money and securities”. In current situation, all goods and products of agricultural (including plantation), mineral and fossil origin are allowed for commodity trading recognized under the FCRA. The national commodity exchanges, recognized by the Central Government, permits commodities
which include precious (gold and silver) and non-ferrous metals, cereals and pulses, ginned and un-ginned cotton, oilseeds, oils and oilcakes, raw jute and jute goods, sugar and jaggery, potatoes and onions, coffee and tea, rubber and spices. Etc.
What is “Commodity Trading”? Commodities trading are a sophisticated form of investing. It is similar to stock trading but instead of buying and selling shares of companies, an investor buys and sells commodities. Like stocks, commodities are traded on exchanges where buyers and sellers can work together to either get the products they need or to make a profit from the fluctuating prices. To completely understand the commodity trading we need to describe two more terms which are similar to each other. a.) Commodity exchange b.) Commodity market
A commodities exchange is an exchange where various commodities and derivatives products are traded. Most commodity markets across the
world trade in agricultural products and other raw materials (like wheat, barley, sugar, maize, cotton, cocoa, coffee, milk products, pork bellies, oil, metals, etc.)
Commodity markets are markets where raw or primary products are exchanged. These raw commodities are traded on regulated commodities exchanges, in which they are bought and sold in standardized contracts
What is Commodity Futures? A Commodity futures is an agreement between two parties to buy or sell a specified and standardized quantity of a commodity at a certain time in future at a price agreed upon at the time of entering into the contract on the commodity futures exchange. The need for a futures market arises mainly due to the hedging function that it can perform. Commodity markets, like any other financial instrument, involve risk associated with frequent price volatility. The loss due to price volatility can be attributed to the following reasons:
Consumer Preferences: In the short-term, their influence on price volatility is small since it is a slow process permitting manufacturers, dealers and wholesalers to adjust their inventory in advance.
Changes in supply: - They are abrupt and unpredictable bringing about wild fluctuations in prices. This can especially noticed in agricultural commodities where the weather plays a major role in affecting the fortunes of people involved in this industry. The futures market has evolved to neutralize such risks through a mechanism; namely hedging.
The objectives of Commodity futures: -
• Hedging with the objective of transferring risk related to the possession of physical assets through any adverse moments in price. Liquidity and Price discovery to ensure base minimum volume in trading of a commodity through market information and demand supply factors that facilitates a regular and authentic price discovery mechanism.
• Maintaining buffer stock and better allocation of resources as it augments reduction in inventory requirement and thus the exposure to risks related with price fluctuation declines. Resources can thus be diversified for investments.
• Price stabilization along with balancing demand and supply position. Futures trading leads to predictability in assessing the domestic prices, which maintains stability, thus safeguarding against any short term adverse price movements. Liquidity in Contracts of the commodities traded also ensures in maintaining the equilibrium between demand and supply.
• Flexibility, certainty and transparency in purchasing commodities facilitate bank financing. Predictability in prices of commodity would lead to stability, which in turn would eliminate the risks associated with running the business of trading commodities. This would make funding easier and less stringent for banks to commodity market players.
Importance of Commodity Trading:-
The primary objectives of any futures exchange are authentic price discovery and an efficient price risk management. The beneficiaries include those who trade in the commodities being offered in the
exchange as well as those who have nothing to do with futures trading. It is because of price discovery and risk management through the existence of futures exchanges that a lot of businesses and services are able to function smoothly. 1. Price Discovery:-Based on inputs regarding specific market information, the demand and supply equilibrium, weather forecasts, expert views and comments, inflation rates, Government policies, market dynamics, hopes and fears, buyers and sellers conduct trading at futures exchanges. This transforms in to continuous price discovery mechanism. The execution of trade between buyers and sellers leads to assessment of fair value of a particular commodity that is immediately disseminated on the trading terminal.
2. Price Risk Management: - Hedging is the most common method of price risk management. It is strategy of offering price risk that is inherent in spot market by taking an equal but opposite position in the futures market. Futures markets are used as a mode by hedgers to protect their business from adverse price change. This could dent the profitability of their business. Hedging benefits who are
involved in trading of commodities like farmers, processors, merchandisers, manufacturers, exporters, importers etc.
3. Import- Export competitiveness: - The exporters can hedge their price risk and improve their competitiveness by making use of futures market. A majority of traders which are involved in physical trade internationally intend to buy forwards. The purchases made from the physical market might expose them to the risk of price risk resulting to losses. The existence of futures market would allow the exporters to hedge their proposed purchase by temporarily substituting for actual purchase till the time is ripe to buy in physical market. In the absence of futures market it will be meticulous, time consuming and costly physical transactions.
4. Predictable Pricing: - The demand for certain commodities is highly price elastic. The manufacturers have to ensure that the prices should be stable in order to protect their market share with the free entry of imports. Futures contracts will enable predictability in domestic prices. The manufacturers can, as a result, smooth out the influence of changes in their input prices very
easily. With no futures market, the manufacturer can be caught between severe short-term price movements of oils and necessity to maintain price stability, which could only be possible through sufficient financial reserves that could otherwise be utilized for making other profitable investments.
5. Benefits for farmers/Agriculturalists: - Price instability has a direct bearing on farmers in the absence of futures market. There would be no need to have large reserves to cover against unfavorable price fluctuations. This would reduce the risk premiums associated with the marketing or processing margins enabling more returns on produce. Storing more and being more active in the markets. The price information accessible to the farmers determines the extent to which traders/processors increase price to them. Since one of the objectives of futures exchange is to make available these prices as far as possible, it is very likely to benefit the farmers. Also, due to the time lag between planning and production, the market-determined price information disseminated by futures exchanges would be crucial for their production decisions.
6. Credit accessibility: - The absence of proper risk management tools would attract the marketing and processing of commodities to high-risk exposure making it risky business activity to fund. Even a small movement in prices can eat up a huge proportion of capital owned by traders, at times making it virtually impossible to payback the loan. There is a high degree of reluctance among banks to fund commodity traders, especially those who do not manage price risks. If in case they do, the interest rate is likely to be high and terms and conditions very stringent. This posses a huge obstacle in the smooth functioning and competition of commodities market. Hedging, which is possible through futures markets, would cut down the discount rate in commodity lending.
7. Improved product quality: - The existence of warehouses for facilitating delivery with grading facilities along with other related benefits provides a very strong reason to upgrade and enhance the quality of the commodity to grade that is acceptable by the exchange. It ensures uniform standardization of commodity trade, including the terms of quality standard: the quality certificates that
are issued by the exchange-certified warehouses have the potential to become the norm for physical trade.
India and Commodity Market
History of Commodity Market in India:The history of organized commodity derivatives in India goes back to the nineteenth century when Cotton Trade Association started futures trading in 1875, about a decade after they started in Chicago. Over the time derivatives market developed in several commodities in India. Following Cotton, derivatives trading started in oilseed in Bombay (1900), raw jute and jute goods in Calcutta (1912), Wheat in Hapur (1913) and Bullion in Bombay (1920). However many feared that derivatives fuelled unnecessary speculation and were detrimental to the healthy functioning of the market for the underlying commodities, resulting in to banning of commodity options trading and cash settlement of commodities futures after independence in 1952. The parliament passed the Forward Contracts (Regulation) Act, 1952, which regulated contracts in Commodities all over the India. The act prohibited options trading in Goods along with cash settlement of forward trades, rendering a crushing blow to the
associations/exchanges, which are granted reorganization from the Government, are allowed to organize forward trading in regulated commodities. The act envisages three tire regulations: (i) Exchange which organizes forward trading in commodities can regulate trading on day-to-day basis; (ii) Forward Markets Commission provides regulatory oversight under the powers delegated to it by the central Government. (iii) The Central Government- Department of Consumer Affairs, Ministry of Consumer Affairs, Food and Public Distribution- is the ultimate regulatory authority. The commodities future market remained dismantled and remained dormant for about four decades until the new millennium when the Government, in a complete change in a policy, started actively encouraging commodity market. After Liberalization and Globalization in 1990, the Government set up a committee (1993) to examine the role of futures trading. The Committee (headed by Prof. K.N. Kabra) recommended allowing futures trading in 17 commodity groups. It also recommended strengthening Forward Markets Commission, and certain amendments to Forward Contracts (Regulation) Act 1952, particularly allowing option trading in goods and registration of brokers with
Forward Markets Commission. The Government accepted most of these recommendations and futures’ trading was permitted in all recommended commodities. It is timely decision since internationally the commodity cycle is on upswing and the next decade being touched as the decade of Commodities. Commodity exchange in India plays an important role where the prices of any commodity are not fixed, in an organized way. Earlier only the buyer of produce and its seller in the market judged upon the prices. Others never had a say. Today, commodity exchanges are purely speculative in nature. Before discovering the price, they reach to the producers, end-users, and even the retail investors, at a grassroots level. It brings a price transparency and risk management in the vital market. A big difference between a typical auction, where a single auctioneer announces the bids and the Exchange is that people are not only competing to buy but also to sell. By Exchange rules and by law, no one can bid under a higher bid, and no one can offer to sell higher than someone else’s lower offer. That keeps the market as efficient as possible, and keeps the traders on their toes to make sure no one gets the purchase or sale before they do. Since 2002, the commodities future market in India has experienced an
unexpected boom in terms of modern exchanges, number of commodities allowed for derivatives trading as well as the value of futures trading in commodities, which crossed $ 1 trillion mark in 2006. Since 1952 till 2002 commodity datives market was virtually non- existent, except some negligible activities on OTC basis. In India there are 25 recognized future exchanges, of which there are three national level multi-commodity exchanges. After a gap of almost three decades, Government of India has allowed forward transactions in commodities through Online Commodity Exchanges, a modification of traditional business known as Adhat and Vayda Vyapar to facilitate better risk coverage and delivery of commodities. The three exchanges are: National Commodity & Derivatives Exchange Limited (NCDEX) Mumbai, Multi Commodity Exchange of India Limited (MCX) Mumbai and National Multi-Commodity Exchange of India Limited (NMCEIL) Ahmedabad.There are other regional commodity exchanges situated in different parts of India.
Legal framework for regulating commodity futures in India:-
The commodity futures traded in commodity exchanges are regulated by the Government under the Forward Contracts Regulations Act, 1952 and the Rules framed there under. The regulator for the commodities trading is the Forward Markets Commission, situated at Mumbai, which comes under the Ministry of Consumer Affairs Food and Public Distribution
Forward Markets Commission (FMC):It is statutory institution set up in 1953 under Forward Contracts (Regulation) Act, 1952. Commission consists of minimum two and maximum four members appointed by Central Govt. Out of these members there is one nominated chairman. All the exchanges have been set up under overall control of Forward Market Commission (FMC) of Government of India.
National Commodities & Derivatives Exchange Limited (NCDEX) National Commodities & Derivatives Exchange Limited (NCDEX) promoted by ICICI Bank Limited (ICICI Bank), Life Insurance Corporation of India (LIC), National Bank of Agriculture and Rural Development (NABARD) and National Stock Exchange of India
Limited (NSC). Punjab National Bank (PNB), Credit Ratting Information Service of India Limited (CRISIL), Indian Farmers Fertilizer Cooperative Limited (IFFCO), Canara Bank and Goldman Sachs by subscribing to the equity shares have joined the promoters as a share holder of exchange. NCDEX is the only Commodity Exchange in the country promoted by national level institutions. NCDEX is a public limited company incorporated on 23 April 2003. NCDEX is a national level technology driven on line Commodity Exchange with an independent Board of Directors and professionals not having any vested interest in Commodity Markets. It is committed to provide a world class commodity exchange platform for market participants to trade in a wide spectrum of commodity derivatives driven by best global practices, professionalism and transparency. NCDEX is regulated by Forward Markets Commission (FMC). NCDEX is also subjected to the various laws of land like the Companies Act, Stamp Act, Contracts Act, Forward Contracts Regulation Act and various other legislations.
NCDEX is located in Mumbai and offers facilities to its members in more than 550 centers through out India. NCDEX currently facilitates trading of 57 commodities.
• Fibers and other:Guar Gum, Guar seeds, Guar, Jute sacking bags, Indian 28 mm cotton, Indian 31mm cotton, Lemon, Grain Bold, Medium Staple, Mulberry, Green Cottons, , , Potato, Raw Jute, Mulberry raw Silk, V-797 Kapas, Sugar, Chilli LCA334
Crude Oil, Furnace oil
Multi Commodity Exchange of India Limited (MCX)
Multi Commodity Exchange of India Limited (MCX) is an independent and de-mutualized exchange with permanent reorganization from Government of India, having Head Quarter in Mumbai. Key share holders of MCX are Financial Technologies (India) Limited, State Bank of India, Union Bank of India, Corporation Bank of India, Bank of India and Canara Bank. MCX facilitates online trading, clearing and settlement operations for commodity futures market across the country. MCX started of trade in Nov 2003 and has built strategic alliance with Bombay Bullion Association, Bombay Metal Exchange, Solvent Extractors Association of India, pulses Importers Association and Shetkari Sanghatana.
MCX deals wit about 100 commodities.
Commodities Traded at MCX:• Bullion:Gold, Silver, Silver Coins,
• Minerals:Aluminum, Copper, Nickel, Iron/steel, Tin, Zinc, Lead
• Spices:Pepper, Red Chili, Jeera, Cardamom, Cinnamon, Clove, Ginger, • Plantation:Cashew Kernel, Rubber, Areca nut, Betel nuts, Coconut, Coffee, • Fiber and others:Kapas, Kapas Khalli, Cotton (long staple, medium staple, short staple), Cotton Cloth, Cotton Yarn, Gaur seed and Guargum, Gur and Sugar, Khandsari, Mentha Oil, Potato, Art Silk Yarn, Chara or Berseem, Raw Jute, Jute Goods, Jute Sacking • Petrochemicals:High Density Polyethylene (HDPE), Polypropylene (PP), Poly Vinyl Chloride (PVC)
• Energy:Brent Crude Oil, Crude Oil, Furnace Oil, Middle East Sour Crude Oil, Natural Gas
National Multi Commodity Exchange of India Limited (NMCEIL) National Multi Commodity Exchange of India Limited (NMCEIL) is the first de-mutualised Electronic Multi Commodity Exchange in India. On 25th July 2001 it was granted approval by Government to organize trading in edible oil complex. It is being supported by Central warehousing Corporation Limited, Gujarat State Agricultural Marketing Board and Neptune Overseas Limited. It got reorganization in Oct 2002. NMCEIL Head Quarter is at Ahmedabad.
Company Profile Indian Commodity Exchange Limited Indian Commodity Exchange Limited A Public—Private Partnership
The commodities futures market in India is only about 3 times the size of physical market, whereas it is more than 10 times the size of physical market in other developed countries. Therefore, the current state of commodities market in India leaves lot of scope for growth in terms of depth and reach of the market as well as attracting new players who are utilizing the services of overseas commodities market due to various reasons like lack of depth in product category they wish to trade in inadequate warehousing facilities at strategic locations, etc.
Indian Commodity Exchange Limited
Indian commodity exchange limited is a screen based on-line derivatives exchange for commodities and has established a reliable, time tested, and a transparent trading platform. It is also in the process of putting in place robust assaying and warehousing facilities in order to facilitate deliveries. It is jointly promoted by Reliance Ex- change Next Infrastructure Limited and MMTC Limited, Indiabulls Financial Services Ltd. KRIBHCO ,Indian Potash Ltd., and IDFC among others, as its partners.
This exchange is ideally positioned to tap the huge scope for increasing the depth and size of commodities' mar- ket and fill in the structural gaps existing in the Indian market. We have head office located in Mumbai and have regional offices spread across the country which covers agri belt, with a vision to encourage participation of farmers, traders and actual users to hedge their positions against the wide price fluctuations.
ICEX would strive to achieve the following:
• Provide fair, transparent and efficient trading platform to all participants.
• Meet the international benchmarks for the Indian commodity market.
• Provide equal opportunity and access to investors all Over the country through the modern communication modes.
• Attract a wide array of end users, financial intermediaries and hedgers.
• Become a major trading hub for most of the commodities.
• To provide product portfolio to suit the trading Community needs in an efficient manner
It provides the widest range of benchmark future products available on any exchange, covering all major commodities. The collective vision is global growth, innovative product development, continually enhanced technology and the highest level of service available on any exchange .It offers future trading in • Agriculture Commodities • Bullions • Base Metals • Energy
Its objective is to serve customers with a global product
round-the-clock electronic trading and strategic alliances with other leading players. It also offers a number of programs and products designed specifically to appeal to a global audience. Competitive advantage of Indian Commodity Exchange
Impeccable lineage: • Joint venture between Public/Private entities • Well capitalized Rs.100 Cr initial capital • Reputation of partners and pan India presence • Key stake holders having rich experience in the do- main viz. commodities, warehousing, financial markets • Professionally driven exchange with an entrepreneurial mindset • Aim to remove discrepancy in the commodities market by building transparency in the exchange • Unprecedented price transparency and market depth
• Speed and Accuracy of Application Software.
• Unique features for faster trading compared to Indian software.
• Fault Tolerant Application Design.
• The Electronic trading platform provided will provide rapid trade execution and would be one of the world’s most flexible, efficient and secure commodities trading systems.
• The Electronic platform would be scalable and flexible, which means new products and functionality can be added quickly and without requiring users to upgrade their own systems.
• Fully equipped with leading data security and encryption
• Our platform solution will be easy to use, functionally rich and offers built-in pre-trade risk management, a real-time order book and deal ticker, and the industry1s implication engine. most sophisticated spread
• Fail over technology with an uptimeof99.99%
• Effective delivery mechanism through public-private warehouses with stringent quality control
• MMTC and IPL1s existing warehouse facilities would be great asset in ensuring delivery obligations of the market participants
• Efficient delivery mechanism through accredited ware- houses
• Independent and professional logistical support
• The exchange will strive for assaying and testing to be of the highest standards so as to avoid quality disputes
• Margin requirements • Position limits at Member I client level • MTM • Settlement guarantees Fund
Clearing and Settlement:
• Efficient clearing and settlement system • Establishing Settlement guarantee fund • Provides the logical conclusion for the trade executed • Supplement the trading activities of the members by processing the margin increase/release request • Work as a billing center for the exchange
Research and Analysis: • Effective Research and analysis (Fundamental/ Technical). • Skilled analysts with rich domain experience • In depth knowledge of the Commodities market • MMTCs domain expertise for designing ideal con- tracts
Customer Support: We ensure that appropriate guidelines are framed for investors and investors are informed about their rights. We also conduct awareness programmers for investors, redress their grievances and formulate arbitration procedures.
Regional Commodity Exchanges
Reliance Exchange Next Reliance Exchange next Limited (R Next), a subsidiary of Reliance Capital Ltd(RCL), is the new initiative of RCL. R Next is spearheading the RCL’s entry in the exchange business. R Next has setup Reliance Spot Exchange, ( RSX) the national electronic spot market or e-mandi. RSX is present across the value chain from trading, clearing, settlement and custody and offers a
wide spectrum of services covering e-auction, intermediation, storage, assaying & grading etc. for the agriculture sector.
Minerals & Metals Trading Corporation of India Limited ,
Government of India enterprise and the largest international trading company of India. It is the largest exporter of Minerals and sin- gle largest importer/ supplier of Bullion & Non-Ferrous Metals in India. MMTC also leads in trading of agro products, fertilizers, coal, hydrocarbons, textiles
lndiabulls Financial Services Limited is a part of lndiabulls group, one of the top business houses in the country with business interests in Real Estate, Infrastructure, Financial Services, Retail, Mul- tiplex and Power sector. lndiabulls Financial Services is one of lndia’s leading and fastest growing private sector financial services companies. It is an integrated financial services powerhouse ranking among the top private sector financial services and banking groups (in terms of net worth).
Krishak Bharati Cooperative Limited, a world premier fertilizer producing cooperative society, registered under Multi- State Cooperative
Societies Act-1985, promoted by Govt. of India, IFFCO, NCDC and other agricultural cooperative societies spread all over the country.
Indian Potash Limited, the biggest canalizing agency (State Trading Enterprise) for import of Urea and other fertilizers on behalf of Government of India, is a major player in Indian Fertilizer Industry with offices and dealers network across the country.
Infrastructure Development Finance Company Limited , a specialized financial intermediary for infra- structure development has funded integrated transportation, urban infrastructure, health care, agri-business infrastructure, education infrastructure, food and
energy telecommunication and infrastructure technology projects. It has taken key initiatives in providing leadership in rationalizing policy and regulatory
How to become a Member? Following types of entities are eligible to become members of Indian Commodity Exchange Limited.,
• Individual I Proprietorship Firm • Registered Partnership Firm • Hindu Undivided Family (HUF) • Private Limited Company • Public Limited Company • Co-operative Societies
The membership of the exchange shall be open
to all market
participants and depending on their specific needs, they offer various categories of member- ship viz. •Trading Member (TM) •Trading cum Clearing Members (TCM) •Professional Clearing Members (PCM) •Institutional Trading cum Clearing Members (ITCM)
How Commodity market works?
There are two kinds of trades in commodities. The first is the spot trade, in which one pays cash and carries away the goods. The second is futures trade. The underpinning for futures is the warehouse receipt. A person deposits certain amount of say, good X in a ware house and gets a warehouse receipt. Which allows him to ask for physical delivery of the good from the warehouse. But some one trading in commodity futures need not necessarily posses such a receipt to strike a deal. A person can buy or sale a commodity future on an exchange based on his expectation of where the price will go. Futures have something called an expiry date, by when the buyer or seller either closes (square off) his account or give/take delivery of the commodity. The broker maintains an account of all dealing parties in which the daily profit or loss due to changes in the futures price is recorded. Squiring off is done by taking an opposite contract so that the net outstanding is nil. For commodity futures to work, the seller should be able to deposit the commodity at warehouse nearest to him and collect the
warehouse receipt. The buyer should be able to take physical delivery at a location of his choice on presenting the warehouse receipt. But at present in India very few warehouses provide delivery for specific commodities. Following diagram gives a fair idea about working of the Commodity market.
Today Commodity trading system is fully computerized. Traders need not visit a commodity market to speculate. With online commodity trading they could sit in the confines of their home or office and call the shots. The commodity trading system consists of certain prescribed steps or stages as follows:
I. Trading: - At this stage the following is the system implemented- Order receiving - Execution - Matching - Reporting - Surveillance - Price limits - Position limits
II. Clearing: - This stage has following system in place- Matching - Registration - Clearing - Clearing limits - Notation - Margining - Price limits - Position limits
- Clearing house.
III. Settlement: - This stage has following system followed as follows- Marking to market - Receipts and payments - Reporting - Delivery upon expiration or maturity.
How to invest in a Commodity Market?
With whom investor can transact a business? An investor can transact a business with the approved clearing member of previously mentioned Commodity Exchanges. The investor can ask for the details from the Commodity Exchanges about the list of approved members.
What is Identity Proof?
When investor approaches Clearing Member, the member will ask for identity proof. For which Xerox copy of any one of the following can be given a) PAN card Number b) Driving License c) Vote ID d) Passport
What statements should be given for Bank Proof? The front page of Bank Pass Book and a canceled cheque of a concerned bank. Otherwise the Bank Statement containing details can be given.
What are the particulars to be given for address proof? In order to ascertain the address of investor, the clearing member will insist on Xerox copy of Ration card or the Pass Book/ Bank Statement where the address of investor is given.
What are the other forms to be signed by the investor? The clearing member will ask the client to sign a) Know your client form b) Risk Discloser Document
The above things are only procedure in character and the risk involved and only after understanding the business, he wants to transact business.
What aspects should be considered while selecting a commodity broker? While selecting a commodity broker investor should ideally keep certain aspects in mind to ensure that they are not being missed in any which way. These factors include • Net worth of the broker of brokerage firm. • The clientele. • The number of franchises/branches. • The market credibility. • The references.
• The kind of service provided- back office functioning being most important. • Credit facility. • The research team. These are amongst the most important factors to calculate the credibility of commodity broker.
Broker:The Broker is essentially a person of firm that liaisons between individual traders and the commodity exchange. In other words the Commodity Broker is the member of Commodity Exchange, having direct connection with the exchange to carry out all trades legally. He is also known as the authorized dealer.
How to become a Commodity Trader/Broker of Commodity Exchange? To become a commodity trader one needs to complete certain legal and binding obligations. There is routine process followed, which is stated by a unit of Government that lays down the laws and acts with
regards to commodity trading. A broker of Commodities is also required to meet certain obligations to gain such a membership in exchange. To become a member of Commodity Exchange the broker of brokerage firm should have net worth amounting to Rs. 50 Lakh. This sum has been determined by Multi Commodity Exchange.
How to become a Member of Commodity Exchange? To become member of Commodity Exchange the person should comply with the following Eligibility Criteria. 1. He should be Citizen of India. 2. He should have completed 21 years of his age. 3. He should be Graduate or having equivalent qualification. 4. He should not be bankrupt. 5. He has not been debarred from trading in Commodities by statutory/regulatory authority, There are following three types of Memberships of Commodity Exchanges.
Trading-cum-Clearing Member (TCM):-
A TCM is entitled to trade on his own account as well as on account of his clients, and clear and settle trades himself. A sole proprietor, Partnership firm, a joint Hindu Undivided Family (HUF), a corporate entity, a cooperative society, a public sector organization or any other Government or non-Government entity can become a TCM. There are two types of TCM, TCM-1 and TCM-2. TCM-1 refers to transferable non-deposit based membership and TCM-2 refers to non-transferable deposit based membership. A person desired to register as TCM is required to submit an application as per the format prescribed under the business rules, along with all enclosures, fee and other documents specified therein. He is required to go through interview by Membership Admission Committee and committee is also empowered to frame rules or criteria relating to selection or rejection of a member.
Institutional Trading-cum-clearing Member (ITCM):Only an Institution/ Corporate can be admitted by the Exchange as a member, conferring upon them the right to trade and clear through the clearing house of exchange as an Institutional Trading-cum-clearing Member (ITCM). The member may be allowed to make deals for himself
as well as on behalf of his clients and clear and settle such deals. ITCMs can also appoint sub-brokers, authorized persons and Trading Members who would be registered as trading members.
Professional Clearing Member (PCM):A PCM entitled to clear and settle trades executed by other members of the exchange. A corporate entity and an institution only can apply for PCM. The member would be allowed to clear and settle trades of such members of the Exchange who choose to clear and settle their trades through such PCM.
Subscriptio Corpora Partnersh Individu te Rs ip 50 Rs. al 50 Rs. 50
MCX Certified Commodity Professional Reference Material
Current Scenario in Indian Commodity Market
Need of Commodity Derivatives for India:India is among top 5 producers of most of the Commodities, in addition to being a major consumer of bullion and energy products. Agriculture contributes about 22% GDP of Indian economy. It employees around 57% of the labor force on total of 163 million hectors of land Agriculture sector is an important factor in achieving a GDP growth of 8-10%. All this indicates that India can be promoted as a major centre for trading of commodity derivatives.
Trends in volume contribution on the three National Exchanges:-
Pattern on Multi Commodity Exchange (MCX):-
MCX is currently largest commodity exchange in the country in terms of trade volumes, further it has even become the third largest in bullion and second largest in silver future trading in the world. Coming to trade pattern, though there are about 100 commodities traded on MCX, only 3 or 4 commodities contribute for more than 80 percent of total trade volume. As per recent data the largely traded commodities are Gold, Silver, Energy and base Metals. Incidentally the futures’ trends of these commodities are mainly driven by international futures prices rather than the changes in domestic demand-supply and hence, the price signals largely reflect international scenario. Among Agricultural commodities major volume contributors include Gur, Urad, Mentha Oil etc. Whose market sizes are considerably small making then vulnerable to manipulations.
Pattern on National Commodity & Derivatives Exchange (NCDEX):NCDEX is the second largest commodity exchange in the country after MCX. However the major volume contributors on NCDEX are agricultural commodities. But, most of them have common inherent problem of small market size, which is making them vulnerable to market manipulations and over speculation. About 60 percent trade on
NCDEX comes from guar seed, chana and Urad (narrow commodities as specified by FMC).
Pattern on National Multi Commodity Exchange (NMCE):NMCE is third national level futures exchange that has been largely trading in Agricultural Commodities. Trade on NMCE had considerable proportion of commodities with big market size as jute rubber etc. But, in subsequent period, the pattern has changed and slowly moved towards commodities with small market size or narrow commodities.
Analysis of volume contributions on three major national commodity exchanges reveled the following pattern,
Major volume contributors: - Majority of trade has been concentrated in few commodities that are
• Non Agricultural Commodities (bullion, metals and energy) • Agricultural commodities with small market size (or narrow commodities) like guar, Urad, Mentha etc.
Trade strategy:It appears that speculators or operators choose commodities or contracts where the market could be influenced and extreme speculations possible. In view of extreme volatilities, the FMC directs the exchanges to impose restrictions on positions and raise margins on those commodities. Consequently, the operators/speculators chose another commodity and start operating in a similar pattern. When FMC brings restrictions on those commodities, the operators once again move to the other commodities. Likewise, the speculators are moving from one commodity to other (from methane to Urad to guar etc) where the market could be influenced either individually or with a group.
Beneficiaries: - So far the beneficiaries from the current nature of trading are Exchangers: - making profit from mounting volumes Arbitragers Operators
In order to understand the extent of progress the trading the trading in Commodity Derivatives has made towards its specified objectives (price discovery and price risk management), the current trends are juxtaposed against the specification
Specified and actual pattern of futures trade:Process Aught to be Commodi There should be large ties demand for and supply of the commodity- no individual or a group of persons concert should be in a position to influence the demand or supply, consequently
Actual Largely Traded are
• Bullion, Metals and • Commodities small market size (or narrow acting in guar, Burmese Urad, Mentha etc. Commodities) like with
the price substantially Towards this, the major Produced or consumed Commodities in the Country such as wheat, rice, jute etc. and India is the top first or second producer of these Commodities. Trade Strategy Hedging together with Over speculation and leading to
Moderate speculation to Manipulation Smoothen the price wide Fluctuations. So far arbitrageurs, Operators etc., Further instances of Wrong
Fluctuations. Beneficia Farmers/producers,, ries Consumers and traders Either through direct Participation or through Price signals.
accruing losses to farmers in case of menthe, and to traders in case Objective Price Discovery s Of imported pulses. • Pure replication of International not Taking in account of Domestic D-S in case of Non-agril. Commodities • Wide from Over speculation and Manipulation in case of Largely traded agril. Risk Management No Commodities such evidences the and fluctuations trends
volatilities commodities futures
More risky for participants. Thus it is evident that the realization of specified objectives is still a distinct destination. It is further, evident from the nature of the commodities largely traded on national exchanges that the factors driving the current pattern of futures trade are purely speculative.
Reasons for prevailing trade pattern:No wide spread participation of all stake holders of commodity markets. The actual benefits may be realized only when all the stake holders in commodity market including producers, traders, consumers etc trade actively in all major commodities like rice, wheat, cotton etc.
Some Suggestions to make futures market as a level playing field for all stake holders:• Creation of awareness among farmers and other rural participants to use the futures trading platform for risk mitigation.
• Contract specifications should have wider coverage, so that a large number of varieties produced across the country could be included. • Development of warehousing and facilities to use the warehouse receipt as a financial instrument to encourage participation farmers. • Development of physical market through uniform grading and standardization and more transparent price mechanisms. • Delivery system of exchanges is not good enough to attract investors. E.g.- In many commodities NCDEX forces the delivery on people with long position and when they tend to give back the delivery in next month contract the exchange simply refuses to accept the delivery on pretext of quality difference and also auctions the product. The traders have to take a delivery or book losses at settlement as there are huge differences between two contracts and also sometimes few contracts are not available for trading for no reason at all. • Contract sizes should have an adequate range so that smaller traders can participate and can avoid control of trading by few big parties.
• Setting of state level or district level commodities trading helpdesk run by independent organization such as reputed NGO for educating farmers. • Warehousing and logistics management structure also needs to be created at state or area level whenever commodity production is above a certain share of national level. • Though over 100 commodities are allowed for Derivatives trading, in practice only a few commodities derivatives are popular for trading. Again most of the trade takes place only on few exchanges. This problem can possibly solved by consolidating some exchanges. • Only about 1% to 5% of total commodity derivatives traded in country are settled in physical delivery due to insufficiencies in present warehousing system. As good delivery system is the back bone of any Commodity trade, warehousing problem has to be handled on a war footing. • At present there are restrictions in movement of certain goods from one state to another. These needs to be removed so that a truly national market could develop for commodities and derivatives.
• Regulatory changes are required to bring about uniformity in Octri and sales tax etc. VAT has been introduced in country in 2005, but, has not yet been uniformly implemented by all states. • A difficult problem in Cash settlement of Commodities Derivatives contract is that, under Forward Contracts Regulation Act 1952 cash settlement of outstanding contracts at maturity is not allowed. That means outstanding contracts at maturity should be settled in physical delivery. To avoid this participants square off their their positions before maturity. So in practice contracts are settled in Cash but before maturity. There is need to modify the law to bring it closer to the wide spread practice and save participants from unnecessary hassle
General Characteristics: Steel is an alloy of iron and carbon, containing less than 2% carbon, 1% manganese and small amount of silicon, phosphorus, sulphur and oxygen. Steel is most important engineering and construction material in the world. It is most important, multi functional and the most adaptable of materials. Steel production is 20 times higher a compared to production of all non-ferrous metals put together. Steel compared to other materials of its type has low production costs. The energy required for extracting iron from ore is about 25% of what is needed for extracting aluminum. There are altogether about 2000 grades of steel developed of which 1500 grades are high-grade steels. The large number of grades gives steel the characteristics of basic production material.
Categories of Steel: Steel market is primarily divided in to two main categories- flat and long. A flat carbon steel product is a plate product or a (hot or cold)
rolled strip product. Plate products vary in dimensions from 10 mm to 200 mm and thin flat rolled products from 1 mm to 10 mm. Plate products are used for ship building, construction, large diameter welded pipes and boiler applications. Thin flat products find end use applications in automotive body panels, domestic ‘white goods’ products, ‘tin cans’ and the whole host of other products from office furniture to heart pacemakers. Plates, HR coils and HR Sheet, CR Sheet and CR coils, GP/GC (galvanized plates and coils) pipes etc. are included in this category. A long steel product is a road or a bar. Typical rod product are the reinforcing rods made from sponge iron for concrete, ingots, billets, engineering products, gears, tools, etc. Wiredrawn products and seamless pipes are also part of the long products group. Bars, rods, structures, railway materials, etc are included in this category. Sponge Iron/ Direct reduced iron (DRI): This is a high quality product produced by reducing iron ore in a solid state and is primarily used as an iron input in electric arc furnace (EAF) steel making process. This industry is an integral part of the steel sector. India is one of the leading countries in terms of sponge iron production. There are a number of coal-based sponge iron/DRI plants (in the eastern and central
region) and also three natural gas based plants (in western part of the country) in the country.
Global Scenario: The total output of the word crude steel in 2006 stood at 945 million tons, resulting in a growth of 6.7% over the previous year. China is the word’s largest crude steel producer in the year 2006 with around 220.12 million tons of steel production, followed by Japan and USA. USA was largest importer of steel products, both finished and semi finished, in 2005, followed by China and Germany. The words largest exporter of semi-finished and finished steel was Japan in 2005, followed by Russia and Ukraine. China is the largest consumer now and consumption of steel by China is estimated to increase by 12-13% in 2007.
Indian Scenario: India is the 8th largest producer of the steel with an annual production of 36.193 million tons, while the consumption is around 30 million tons.
Iron & steel can be freely exported and imported from India. India is a net exporter of steel. The Government of India has taken a number of policy measures, such as removal of iron & steel industry from the list of industries reserved for public sector, deregulation of price and distribution of iron & steel and lowering import duty on capital goods and raw materials, since liberalization for the growth and development of Indian iron & steel industry. After liberalization India has seen huge scale addition to its steel making capacity. The country faces shortage of iron and steel materials.
Factors Influencing Demand & Supply of Steel Long and Steel Flat: The demand for steel is dependent on the overall health of the economy and the in fracture development activities being undertaken. The steel prices in the Indian market primarily depend on the domestic demand and supply conditions, and international prices. Government and different producer and consumer associations regularly monitor steel prices. The duty imposed on import of steel and its fractions also have an impact on steel prices. The price trend in steel in Indian markets has been
a function of World’s economic activity. Prices of input materials of iron and steel such as power tariff, fright rates and coal prices, also contribute Percentage Change No. of Times Ingots- Mandi HRC 2.5 Mumbai HRC 2.0 > 5% 2 8 12 10 3 4 10 11 6 8 2-5% < 2%
Imported HRC fob- Europe 5 9 to the rise in the input costs for steel making.
Monthly Variations in Steel Prices from Feb 2005- Dec 2006: -2
MCX certified Commodity Professional Reference Material.
Contract specifications of Steel Flat Symbol STEELFLAT Description STEELFLATMMMYY Trading Period Mondays through Saturdays Trading session Monday to Friday: 1st session: 10.00 am to 5.00 pm 2nd session: 5.30 pm to 8.00 pm Saturday: 10.00 am to 2.00 pm No. of contracts a year 12 Contact Duration 4 months Trading Trading unit 25 MT Price Quote Rs./ton, Ex-Taloj Kalambo Maximum order size Tick size (minimum Price movement) Daily price limits Initial margin Special margin (excluding execise duty and sales tax). 200 MT Rs. 10 4% 5% In case of additional volatility, a special margin of 2% or such other percentage, as deemed fit, will be imposed
immediately on, both buy and sale side in respect of all outstanding position, which will remain in force of next three days, after which the special margin
will be relaxed. Maximum Allowable For individual clients: 1,00,000 MT Open Position For a member collectively for all clients: 25% of open market position. Delivery Delivery unit 25 MT with tolerance limit Between 23.5 MT to 26.5 MT Warehouses at Taloja/ Kalamboli
Delivery Center(s) Quality Specifications HR coil conforming to the following specification:
Thickness 2 mm Width either 1250mm or 910 mm at seller’s option. It should confirm to IS 11513 Grade D/SAE 1008 (International equivalent)
Delivery is acceptable only in coil form.
Contract specifications of Steel Long Symbol STEELLONG Description STEELLONGMMMYY
Trading Period Trading session
Mondays through Saturdays Monday to Friday: 1st session: 10.00 am to 5.00 pm 2nd session: 5.30 pm to 8.00 pm
Saturday: 10.00 am to 2.00 pm No. of contracts a year 12 Contact Duration 4 months Trading Trading unit 15 MT Price Quote Rs./ton, Ex- Mandi Gobindgarh (including excise duty but excluding Maximum order size Tick size (minimum Price movement) Daily price limits Initial margin Special margin sales tax). 300 MT Rs. 10 4% 5% In case of additional volatility, a special margin of 2% or such other percentage, as deemed fit, will be imposed
immediately on, both buy and sale side in respect of all outstanding position, which will remain in force of next three days, after which the special margin will be relaxed. Maximum Allowable For individual clients: 1,00,000 MT
For a member collectively for all clients: 25% of open market position.
Delivery Delivery unit
15 MT with tolerance limit Between 13.5 MT to 16.5 MT Warehouses at Mandi Gobindgarh
Delivery Center(s) Quality Specifications Mild steels ingots “3 ½ * 4 ½ inch” Carbon composition: Below 0.25% Manganese: Above 0.45%
Material should be physically sound. It should have no hollowness, no piping no rising. Its surface should be plain.
Quality Specifications: -
Sponge Iron Futures Sponge Iron Lumps
Chemical Properties (only Magnetic Portion): -
• Degree of Metallization: 88 +/- 2%. • Total Iron: 91%. • Carbon: 0.2% to 0.3%. • Sulphur: 0.05% Max. • Phosphorus: 0.06 Max. • Sio2 + Al2o3: 6% or Max. • Char & other process Contaminants: 1% Max. • Size: 3 to 20 mm • Undersize arising during tailings (-3mm): 5% Max
Steel Flat: HR Coil confirming to the following specification: • Thickness 2mm • Width either 1250 mm or 910 mm at seller’s option. • It should confirm to IS 11513 Grade D/ SALE 1008 (international equivalent) • Delivery is acceptable only in coil form. Steel Long (Bhavnagar): -
• Mild steel ingots 3 ½ * 4 ½ inch. • Carbon composition: Below 0.25% • Manganese: Above 0.45% • Material should be physically sound. It should have no hollowness, no piping and no rising. Its surface should be plain. Steel Long (Govindgarh): • Mild steel ingots 3 ½ * 4 ½ inch. • Carbon composition: Below 0.25% • Manganese: Above 0.45% • Material should be physically sound. It should have no hollowness, no piping and no rising. Its surface should be plain.
WHEAT Wheat is cereal grain and consumed worldwide. Wheat is more popular than any other cereal grain for use in baked goods. Its popularity stems from the gluten that forms when lour is mixes with water. Wheat is the most widely grown cereal grain in the world.
Global and Indian Scenario: The world wheat production in the recent years has been observed to be hovering between 555 million tons to 625 million tons a year. The biggest cultivators of wheat are EU 25, China, India, USA, Russia, Australia, Canada, Pakistan, Turkey and Argentina. EU 25, China, India and US are the four largest producers account for around 60% of total global production. World’s wheat consumption is continuously growing with growth in a population, as it is one of the major staple foods across the world. The major consuming countries of wheat are EU, China, India, Russia, USA and Pakistan. India has largest area in the world under wheat. However, in terms of production, India is second largest behind China. In India, Wheat is sown during October to December and harvested during March to May. The wheat marketing season in India is assumed to begin from April every year. The major wheat producing states in India are Utter Pradesh, Punjab, Haryana, Madhya Pradesh, Rajastan and Bihar. Which together account for around 93% of total production. In terms of productivity, Punjab stands first followed by Haryana, Rajastan, UP, Gujarat, Bihar and MP. Indian wheat is largely soft/medium hard, medium protein,
bread wheat. India is also produces around 1.5 million tons of durum wheat, mostly in central and western India, which is not segregated and marketed separately. India consumes around 72-74 million tons of Wheat every year. There are around 1000 large flourmills in India, with a milling capacity of around 15 million tons. The total procurement of wheat by Government agencies during last 15 years from 8 to 20 million tons, accounting for only 15-20% of the total production. India exported around 5 m illion tons subsidized by Government in 2004-05, as a result of surplus stock. Recently Govt. took decision to import wheat in view of, declining stocks and increasing demand.
Key market moving Factors: Price tends to be lower as harvesting progresses and produce starts coming in to the market. At the time sowing and before harvesting price tend to rise in a view of tight supply situation. Weather has profound influence on wheat production. Temperature plays crucial role towards maturity of wheat and productivity. Change in Minimum Support Price (MSP) by Govt. and the stock available with Food corporation of India and the release from official
stock influence of the price. Though, international trade is limited, the ups and downs in the production and consumption at all the major/minor producing and consuming nation dose influence the long term price trend.
Contract specifications of Wheat Contract Period Five Months Trading Period Mondays through Saturdays Trading session Monday to Friday: 10.00 am to 5.00 pm Saturday: 10.00 am to 2.00 pm Trading Trading unit Quotation based value Maximum order size Tick size (minimum Price movement) Price Quotation 10 MT 1 Quintal 500 MT 10 Paise Ex-warehouse Delhi (including all
taxes, levies and sales tax/ VAT, as the Daily price limits Initial margin Special margin case may be) 4% 5% In case of additional volatility, a special margin at such other percentage, as deemed fit will be imposed immediately
on, both buy and sale side in respect of all outstanding position, which will remain in force of next 2 days, after which the special margin will be relaxed. Maximum Allowable Clientwise- 20000 MT, Member wiseOpen Position Delivery Delivery unit 80000 MT or 20% of open position, which ever is higher. 10 MT with tolerance limit of 5%
Delivery Margin 25% Delivery Center(s) Warehouses at Delhi Quality Specifications Wheat of Standard Mill variety confirming to the following quality standerds will be delieverable. The material will be tested using a 3mm sieve.
damaged not to exceed 1 per 100 kernels. Shrunken 3.00% (Max)
Shriveled & broken grains Total defects (a+b+c) Acceptable up to Below 6% 8% With rebate on 1:1 basis
Rejected total defect is Above 8% Teat weight up to 76 76kg/hl. Min. acceptable with rebate of kg/hl 150 grams per kg/hl or pro-rata variance in hector liter weight deducted per quintal Rejected Moisture Acceptable Reject able Below 74 kg/hl Below 74 kg/hl 11% (Max)13% With rebate 1:1 Above 13%
Quality Specifications: -
Wheat of Standard Mill variety conforming to the following quality standards will be deliverable; The material will be tested by using 3 mm sieve. Defects: 1. Foreign Matter 2.0% (maximum) 2.0% (maximum) provided that
2. Damaged Kernel
infestation damaged not exceed 1 Per 100 kernels.
3. Sunken, Shriveled and Broken grains Total Defects (a+b+c) Acceptable Rejected if total defects Total Weight Up to 74 kg/hl
3.00% (maximum) Below 6% Up to 8% with rebate on 1:1 basis Above 8% 76 kg/hl. (minimum) Acceptable with rebate of 150 grams per kg/hl or pro-rata
variance in hector liter weight deducted delivered. Below 74 kg/hl Moisture Acceptable Reject able Packing Rejected 11% (maximum) Up to 13% with rebate 1:1 Above 135 Packing should be in B Twill once used 100kg jute bags, the tare weight deduction per bag for net weight calculation shall be 1 kg per quintal of gross weight.
Terms and Definitions related to Commodity Market: • Accruals:- Commodities on hand ready for shipment, storage and manufacture
• Arbitragers: - Arbitragers are interested in making purchase and sale in different markets at the same time to profit from price discrepancy between the two markets.
• At the Market: - An order to buy or sell at the best price possible at the time an order reaches the trading pit.
• Basis: - Basis is the difference between the cash price of an asset and futures price of the underlying asset. Basis can be negative or positive depending on the prices prevailing in the cash and futures.
• Basis grade: - Specific grade or grades named in the exchanges future contract. The other grades deliverable are subject to price of underlying futures
• Bear: - A person who expects prices to go lower.
• Bid: - A bid subject to immediate acceptance made on the floor of exchange to buy a definite number of futures contracts at a specific price.
• Breaking: - A quick decline in price.
• Bulging: - A quick increase in price.
• Bull: - A person who expects prices to go higher.
• Buy on Close: - To buy at the end of trading session at the price within the closing range.
• Buy on opening: - To buy at the beginning of trading session at a price within the opening range.
• Call: - An option that gives the buyer the right to a long position in the underlying futures at a specific price, the call writer (seller) may be assigned a short position in the underlying futures if the buyer exercises the call.
• Cash commodity: - The actual physical product on which a futures contract is based. This product can include agricultural
commodities, financial instruments and the cash equivalent of index futures.
• Close: - The period at the end of trading session officially designated by exchange during which all transactions are considered made “at the close”.
• Closing price: - The price (or price range) recorded during the period designated by the exchange as the official close.
• Commission house: - A concern that buys and sells actual commodities or futures contract for the accounts of customers.
• Consumption Commodity: - Consumption commodities are held mainly for consumption purpose. E.g. Oil, steel
• Cover: - The cancellation of the short position in any futures contract buys the purchase of an equal quantity of the same futures contract.
• Cross hedge: - When a cash commodity is hedged by using futures contract of other commodity.
• Day orders: - Orders at a limited price which are understood to be good for the day unless expressly designated as an open order or “good till canceled” order.
• Delivery: - The tender and receipt of actual commodity, or in case of agriculture commodities, warehouse receipts covering such commodity, in settlement of futures contract. Some contracts settle in cash (cash delivery). In which case open positions are marked to market on last day of contract based on cash market close.
• Delivery month: - Specified month within which delivery may be made under the terms of futures contract.
• Delivery notice: - A notice for a clearing member’s intention to deliver a stated quantity of commodity in settlement of a short futures position.
• Derivatives: - These are financial contracts, which derive their value from an underlying asset. (Underlying assets can be equity, commodity, foreign exchange, interest rates, real estate or any other
asset.) Four types of derivatives are trades forward, futures, options and swaps. Derivatives can be traded either in an exchange or over the counter.
• Differentials: - The premium paid for grades batter than the basis grade and the discounts allowed for the grades. These differentials are fixed by the contract terms on most exchanges.
• Exchange: - Central market place for buyers and sellers. Standardized contracts ensure that the prices mean the same to everyone in the market. The prices in an exchange are determined in the form of a continuous auction by members who are acting on behalf of their clients, companies or themselves.
• Forward contract: - It is an agreement between two parties to buy or sell an asset at a future date for price agreed upon while signing agreement. Forward contract is not traded on an exchange. This is oldest form of derivative contract. It is traded in OTC Market. Not on an exchange. Size of forward contract is customized as per the terms of agreement between buyer and seller. The contract price of
forward contract is not transparent, as it is not publicly disclosed. Here valuation of open position is not calculated on a daily basis and there is no requirement of MTM. Liquidity is the measure of frequency of trades that occur in a particular commodity forward contract is less liquid due to its customized nature. In forward contracts, counter- party risk is high due to customized & bilateral nature of the transaction. Forward contract is not regulated by any exchange. Forward contract is generally settled by physical delivery. In this case delivery is carried out at delivery center specified in the customized bilateral agreement.
• Futures Contract:- It is an agreement between two parties to buy or sell a specified and standardized quantity and quality of an asset at certain time in the future at price agreed upon at the time of entering in to contract on the futures exchange. It is entered on centralized trading platform of exchange. It is standardized in terms of quantity as specified by exchange. Contract price of futures contract is transparent as it is available on centralized trading screen of the exchange. Here valuation of Mark-to-Mark position is
calculated as per the official closing price on daily basis and MTM
margin requirement exists. Futures contract is more liquid as it is traded on the exchange. In futures contracts the clearing-house becomes the counter party to each transaction, which is called novation. Therefore, counter party risk is almost eliminated. A regulatory authority and the exchange regulate futures contract. Futures contract is generally cash settled but option of physical settlement is available. Delivery tendered in case of futures contract should be of standard quantity and quality as specified by the exchange.
• Futures commission merchant: - A broker who is permitted to accept the orders to buy and sale futures contracts for the consumers.
• Futures Funds: - Usually limited partnerships for investors who prefer to participate in the futures market by buying shares in a fund managed by professional traders or commodity trading advisors.
• Futures Market:-It facilitates buying and selling of standardized contractual agreements (for future delivery) of underlying asset as
the specific commodity and not the physical commodity itself. The formulation of futures contract is very specific regarding the quality of the commodity, the quantity to be delivered and date for delivery. However it does not involve immediate transfer of ownership of commodity, unless resulting in delivery. Thus, in futures markets, commodities can be bought or sold irrespective of whether one has possession of the underlying commodity or not. The futures market trade in futures contracts primarily for the purpose of risk management that is hedging on commodity stocks or forward buyers and sellers. Most of these contracts are squared off before maturity and rarely end in deliveries.
• Hedging: - Means taking a position in futures market that is opposite to position in the physical market with the objective of reducing or limiting risk associated with price.
• In the money: - In call options when strike price is below the price of underlying futures. In put options, when the strike price is above the underlying futures. In-the-money options are the most expensive options because the premium includes intrinsic value.
• Index Futures: - Futures contracts based on indexes such as the S & P 500 or Value Line Index. These are the cash settlement contracts.
• Investment Commodities: - An investment commodity is generally held for investment purpose. e.g. Gold, Silver
• Limit: - The maximum daily price change above or below the price close in a specific futures market. Trading limits may be changed during periods of unusually high market activity.
• Limit order: - An order given to a broker by a customer who has some restrictions upon its execution, such as price or time.
• Liquidation: - A transaction made in reducing or closing out a long or short position, but more often used by the trade to mean a reduction or closing out of long position.
• Local: - Independent trader who trades his/her own money on the floor of the exchanges. Some local act as a brokers as well, but are subject to certain rules that protect customer orders.
• Long: - (1) The buying side of an open futures contract or futures option; (2) a trader whose net position in the futures or options market shows an excess of open purchases over open sales.
• Margin: - Cash or equivalent posted as guarantee of fulfillment of a futures contract (not a down payment).
• Margin call: - Demand for additional funds or equivalent because of adverse price movement or some other contingency.
• Market to Market: - The practice of crediting or debating a trader’s account based on daily closing prices of the futures contracts he is long or short.
• Market order: - An order for immediate execution at the best available price.
• Nearby: - The futures contract closest to expiration.
• Net position: - The difference between the open contracts long and the open contracts short held in any commodity by any individual or group.
• Offer: - An offer indicating willingness to sell at a given price (opposite of bid).
• On opening: - A term used to specify execution of an order during the opening.
• Open contracts: - Contracts which have been brought or sold without the transaction having been completed by subsequent sale, repurchase or actual delivery or receipt of commodity.
• Open interest: - The number of “open contracts”. It refers to unliquidated purchases or sales and never to their combined total.
• Option: - It gives right but not the obligation to the option owner, to buy an underlying asset at specific price at specific time in the future.
• Out-of-the money: - Option calls with the strike prices above the price of the underlying futures, and puts with strike prices below the price of the underlying futures.
• Over the counter: - It is alternative trading platform, linked to network of dealers who do not physically meet but instead communicates through a network of phones & computers.
• Pit: - An octagonal platform on the trading floor of an exchange, consisting of steps upon which traders and brokers stand while trading (if circular called ring).
• Point: - The minimum unit in which changes in futures prices may be expressed (minimum price fluctuation may be in multiples of points).
• Position: - An interest in the market in the form of open commodities.
• Premium: - The amount by which a given futures contract’s price or commodity’s quality exceeds that of another contract or commodity (opposite of discount). In options, the price of a call or put, which the buyer initially pays to the option writer (seller).
• Price limit: - The maximum fluctuation in price of futures contract permitted during one trading session, as fixed by the rules of a contract market.
• Purchase and sales statement: - A statement sent by FMC to a customer when his futures option has been reduced or closed out (also called ‘P and S”)
• Put: - In options the buyer of a put has the right to continue a short position in an underlying futures contract at the strike price until the option expires; the seller (writer) of the put obligates himself to
take a long position in the futures at the strike price if the buyer exercises his put.
• Range: - The difference between high and low price of the futures contract during a given period.
• Ratio hedging: - Hedging a cash position with futures on a less or more than one-for-one basis.
• Reaction: - The downward tendency of a commodity after an advance.
• Round turn: - The execution of the same customer of a purchase transaction and a sales transaction which offset each other.
• Round turn commission: - The cost to the customer for executing a futures contract which is charged only when the position is liquidated.
• Scalping: - For floor traders, the practice of trading in and out of contracts through out the trading day in a hopes for making a series of small profits.
• Settlement price: - The official daily closing price of futures contract, set by the exchange for the purpose of setting margins accounts.
• Short: - (1) The selling of an option futures contract. (2) A trader whose net position in the futures market shows an excess of open sales over open purchases.
• Speculator: - Speculator is an additional buyer of the commodities whenever it seems that market prices are lower than they should be.
• Spot Markets:-Here commodities are physically brought or sold on a negotiated basis.
• Spot price: - The price at which the spot or cash commodity is selling on the cash or spot market.
• Spread: - Spread is the difference in prices of two futures contracts.
• Striking price: - In options, the price at which a futures position will be established if the buyer exercises (also called strike or exercise price).
• Swap: - It is an agreement between two parties to exchange different streams of cash flows in future according to predetermined terms.
• Technical analysis (charting): - In price forecasting, the use of charts and other devices to analyze price-change patters and changes in volume and open interest to predict future market trends (opposite of fundamental analysis).
• Time value: - In options the value of premium is based on the amount of time left before the contract expires and the volatility of the underlying futures contract. Time value represents the portion of the premium in excess of intrinsic value. Time value diminishes as the expiration of the options draws near and/or if the underlying futures become less volatile.
• Volume of trading (or sales): - A simple addition of successive futures transactions (a transaction consists of a purchase and matching sale).
• Writer: - A sealer of an option who collects the premium payment from the buyer.
This decade is termed as Decade of Commodities. Prices of all commodities are heading northwards due to rapid increase in demand for commodities. Developing countries like
China are voraciously consuming the commodities. That’s why globally commodity market is bigger than the stock market. India is one of the top producers of large number of commodities and also has a long history of trading in commodities and related derivatives. The Commodities Derivatives market has seen ups and downs, but seems to have finally arrived now. The market has made enormous progress in terms of Technology, transparency and trading activity. Interestingly, this has happened only after the Government protection was removed from a number of Commodities, and market force was allowed to play their role. This should act as a major lesson for policy makers in developing countries, that pricing and price risk management should be left to the market forces rather than trying to achieve these through administered price mechanisms. The management of price risk is going to assume even greater importance in future with the promotion of free trade and removal of trade barriers in the world. As majority of Indian investors are not aware of organized commodity market; their perception about is of risky to very risky investment. Many of them have wrong impression about commodity market in their minds. It makes them specious
towards commodity market. Concerned authorities have to take initiative to make commodity trading process easy and simple. Along with Government efforts NGO’s should come forward to educate the people about commodity markets and to encourage them to invest in to it. There is no doubt that in near future commodity market will become Hot spot for Indian farmers rather than spot market. And producers, traders as well as consumers will be benefited from it. But for this to happen one has to take initiative to standardize and popularize the Commodity Market.
• Trading Commodities and Financial Futures: A Step by Step guide to Mastering the Market, 3rd Edition by George Kleinman
• Options, Futures and Other Derivatives by Johan C. Hull
• MCX Certified Commodity Professional Reference Material