The commodity futures trading, consists of a futures contract, which is a legally binding agreement providing for the delivery of the underlying asset or financial entities at specific date in the future. Like all future contracts, commodity futures are agreements to buy or sell something at a later date and at a price that has been fixed earlier by the buyer and seller. So, for example, a cotton farmer may agree to sell his output to a textiles company many months before the crop is ready for actual harvesting. This allows him to lock into a fixed price and protect his earnings from a steep drop in cotton prices in the future. The textiles company, on the other hand, has protected itself against a possible sharp rise in cotton prices. The complicating factor is quality. Commodity futures contracts have to specify the quality of goods being traded.
The commodity exchanges guarantee that the buyers and sellers will stick to the terms of the agreement. When one buys or sells a futures contract, he is actually entering into a contractual obligation which can be met in one of 2 ways. First, is by making or taking delivery of the commodity. This is the exception, not the rule however, as less than 2% of all the futures contracts are met by actual delivery. The other way to meet one’s obligation, the method which everyone most likely will use, is by “offset”. Very simply, offset is making the opposite or offsetting sale or purchase of the same number of contracts sold, sometimes prior to the expiration of the date of the contract. This can be easily done because futures contracts are standardized.
The futures market in commodities offers both cash and delivery- based settlement. Investors can choose between the two. If the buyer chooses to take delivery of the commodity, a transferable receipt from the warehouse where goods are stored is issued in favour of the buyer. On producing this receipt, the buyer can claim the commodity from the warehouse.
All open contracts not intended for delivery are cash settled. While speculators and arbitrageurs generally prefer cash settlement, commodity stockist and wholesalers go for delivery. The options to square of the deal or to take delivery can be changed before the last date of contract expiry. In the case of delivery- based trades, the margin rises to 20-25% of the contract value and the seller is required to pay sales tax on the transaction.
In a commodity market, hedging is done by a miller, processor, stockiest of goods, or the cultivator of the commodity. Sometimes exporters, who have agreed to sell at a particular price, need to be a hedger in a futures and options market. All these persons are exposed to unfavorable price movements and they would like to hedge their cash positions.
Speculator does not have any position on which they enter in futures options market. They only have a particular view about the future price of a particular commodity. They consider various fundamental factors like demand and supply, market positions, open interests, economic fundamentals internal events, rainfall, crop predictions, government policies etc. and also considering the technical analysis, they are either bullish about the future process or have a bearish outlook.
In the first scenario, they buy futures and wait for rise in price and sell or unwind their position the moment they earn expected profit. If their view changes after taking a long position after taking into consideration the latest developments, they unwind the transaction by selling futures and limiting the losses. Speculators are very essential in all markets. They provide market to the much desired volume and liquidity; these in turn reduce the cost of transactions. They provide hedgers an opportunity to manage their risk by assuming their risk.
e is basically risk averse. He enters in to those contracts where he can earn risk less profits. When markets are imperfect, buying in one market and simultaneous selling in another market gives risk less profit. It may be possible between two physical markets, same for 2 different periods or 2 different contracts.
Growth of the commodity futures trading in India
Investment in India has traditionally meant property, gold and bank deposits. The more risks taking investors choose equity trading. But commodity trading never forms a part of conventional investment instruments. As a matter of fact, future trading in commodities was banned in India in mid 1960's due to excessive speculation.
Commodity trading is finding favor with Indian investors and is been seen as a separate asset class with good growth opportunities. For diversification of portfolio beyond shares, fixed deposits and mutual funds, commodity trading offers a good option for long term investors and arbitrageurs and speculators, and, now, with daily global volumes in commodity trading touching three times that of equities, trading in commodities cannot be ignored by Indian investors.
The strong upward movement in commodities, such as gold, silver, copper, cotton and oilseeds, presents the right opportunity to trade in commodities. Due to heavy fall down in stock market people are finding the safe option to invest and commodity future is providing them that direction.
India has three national level multi commodity exchanges with electronic trading and settlement systems.
The National Commodity and Derivative Exchange (NCDEX).
The Multi Commodity Exchange of India (MCX)
The National Multi Commodity Exchange of India (NMCE)
The National Board of Trading in Derivatives (NBOT)
India , which allowed futures trading in commodities in 2003, has one of the fastest-growing commodity futures markets with a combined trade turnover of 40.66 trillion rupees in 2007/08.
Indian commodity futures trade rose 29.74 percent to 43.93 trillion rupees during the first ten and-a-half-months of financial year 2008/09, helped mainly by the surging trade in bullion, official data showed.
Turnover at Indian commodity bourses rose 39 percent to 31.54 trillion rupees from April 1 to Nov. 15 from the year-ago period, data from regulator Forward Markets Commission (FMC) showed.
Turnover rose 3.5 percent to 2.33 trillion rupees in the fortnight ended Feb. 15, 2009 , data from regulator Forward Markets Commission (FMC)
Trade was most active in gold, silver, crude oil, copper and zinc in energy and metals pack during the period, data showed.
Futures trade in bullion jumped 75.89 percent to 24.45 trillion rupees, accounting for more than half of the total trade from in April 1, 2008 - Feb. 15, 2009 period. It rose 17.79 percent to 1.42 trillion rupees in the fortnight to Feb. 15.
" India 's commodity futures trade is set to grow more than 40% to Rs57 trillion in the year to March 2009, despite trading curbs on eight commodities,"said the chairman of the Forward Markets Commission.